|)art, 

y ri^e  Economic 


THE  CAUSE  AND  EXTENT  OF  THE  RECENT  INDUS- 
TRIAL PROGRESS  OF  GERMANY.  By  Earl  D.  Howard. 

THE  CAUSES  OF  THE  PANIC  OF  1893.  By  William  J. 
Lauck. 

INDUSTRIAL  EDUCATION.  By  Harlow  Stafford  Person, 
Ph.D. 

FEDERAL  REGULATION  OF  RAILWAY  RATES.  By  Al- 
bert N.  Merritt,  Ph.D. 

SHIP  SUBSIDIES.  An  Economic  Study  of  the  Policy  of  Sub- 
sidizing  Merchant  Marines.  By  Walter  T.  Dimmore. 

SOCIALISM:  A  CRITICAL  ANALYSIS.     By  O.  D.  Skelton. 

INDUSTRIAL  ACCIDENTS  ANDTHEIR  COMPENSATION. 
By  Gilbert  L.  Campbell,  B.  S. 

THE  STANDARD  OF  LIVING  AMONG  THE  INDUSTRIAL 
PEOPLE  OF  AMERICA.  By  Frank  H.  Streightoff. 

THE    NAVIGABLE   RHINE.     By  Edwin  J.  Clapp. 

HISTORY  AND  ORGANIZATION  OF  CRIMINAL  STATIS- 
TICS IN  THE  UNITED  STATES.  By  Louis  Newton 
Robinson. 

SOCIAL  VALUE.     By  B.  M.  Anderson,  Jr. 
FREIGHT  CLASSIFICATION.     By  J.  F.  Strombeck. 

WATERWAYS  VERSUS  RAILWAYS.  By  Harold  Glenn 
Moulton. 

THE  VALUE  OF  ORGANIZED  SPECULATION.  By  Harri- 
son H.  Brace. 

INDUSTRIAL  EDUCATION:  ITS  PROBLEMS,  METHODS 
AND  DANGERS.  By  Albert  H.  Leake. 

THE  UNITED  STATES  INTERNAL  TAX  HISTORY  FROM 
I  86 1  TO  I  87 1 .  By  Harry  Edwin  Smith. 

WELFARE  AS  AN  ECONOMIC  QUANTITY.  By  G.  P.  Wat- 
kins. 

CONCILIATION  AND  ARBITRATION  IN  THE  COAL  IN- 
DUSTRY IN  THE  UNITED  STATES.  By  Arthur  E.  Suf- 
fern. 

THE  CANADIAN  IRON  AND  STEEL  INDUSTRY.  By  W.  J. 
A.  Donald. 

THE  TIN   PLATE  INDUSTRY.     By  D.  E.  Dunbar. 

THE  MEANS  AND  METHODS  OF  AGRICULTURAL  EDU- 
CATION. By  Albert  H .  Leake. 

THE  TAXATION  OF  LAND  VALUE.    By  Yetta  Scheftel. 
RAILROAD  VALUATION.     By  Homer  Bews  Vanderblue. 

HOUGHTON  MIFFLIN  COMPANY 
BOSTON  AND  NEW  YORK 


& 


XXIII 
RAILROAD  VALUATION 


RAILROAD  VALUATION 


BY 


HOMER  BEWS  VANDERBLUE,  PH.D. 

ASSOCIATE  PROFESSOR  OF  TRANSPORTATION 

NORTHWESTERN  UNIVERSITY 

SCHOOL  OF  COMMERCE 


BOSTON  AND  NEW  YORK 
HOUGHTON  MIFFLIN  COMPANY 

(fcfee  tfifcergiDe  prejtf  Cambridge 
1917 


COPYRIGHT,    1917,   BY   HART,   SCHAFFNER    &   MARX 
ALL  RIGHTS  RESERVED 

Published  March  tqrj 


••:•!;•• 


TO 
MY   MOTHER 


364746 


PREFACE 

THIS  series  of  books  owes  its  existence  to  the  generosity 
of  Messrs.  Hart,  Schaffner  &  Marx,  of  Chicago,  who  have 
shown  a  special  interest  in  trying  to  draw  the  attention  of 
American  youth  to  the  study  of  economic  and  commercial 
subjects.  For  this  purpose  they  have  delegated  to  the  un- 
dersigned committee  the  task  of  selecting  or  approving  of 
topics,  making  announcements,  and  awarding  prizes  an- 
nually for  those  who  wish  to  compete. 

For  the  year  ending  June  1,  1915,  there  were  offered:  — 

In  Class  A,  which  included  any  American  without  re- 
striction, a  first  prize  of  $1000,  and  a  second  prize  of  $500. 

In  Class  B,  which  included  any  who  were  at  the  time 
undergraduates  of  an  American  college,  a  first  prize  of 
$300,  and  a  second  prize  of  $200. 

Any  essay  submitted  in  Class  B,  if  deemed  of  sufficient 
merit,  could  receive  a  prize  in  Class  A. 

The  present  volume,  submitted  in  Class  A,  was  awarded 
second  prize  in  that  class. 

J.  LAURENCE  LAUGHUN,  Chairman, 

University  of  Chicago. 
J.  B.  CLARK, 

Columbia  University. 
HENRY  C.  ADAMS, 

University  of  Michigan. 
HORACE  WHITE, 

New  York  City. 
EDWIN  F.  GAY, 

Harvard  University. 


AUTHOR'S  PREFACE 

THE  present  volume  is  a  study  in  the  Economics  of 
Railroads.  But  it  is  also  a  study  in  the  Economics  of  the 
Distribution  of  Income.  To  this  circumstance  is  due  the 
frequent  abbreviation  of  the  argument  through  the  use  of 
the  terminology  peculiar  to  that  field  of  the  science.  The 
meaning  of  such  terms  as  differential  returns,  economic 
rent,  capital  goods,  and  capitalization  of  income,  should, 
however,  be  readily  apparent  from  the  context.  I  have 
aimed  to  conform  my  usage  to  that  of  Professor  F.  W. 
Taussig,  in  his  Principles  of  Economics. 

In  other  directions,  as  well,  I  am  greatly  indebted  to 
Professor  Taussig.  It  was  under  his  direction  that  the 
study  was  brought  into  its  present  form.  I  am  also  in- 
debted to  Professor  F.  S.  Deibler,  who  directed  a  prelimi- 
nary investigation  made  when  I  was  an  undergraduate  at 
Northwestern.  Professor  J.  M.  Clark,  of  the  University 
of  Chicago,  has  given  me  helpful  suggestions  in  the  final 
preparation  of  the  paper;  and  my  colleagues,  Professors 
F.  E.  Richter  and  W.  E.  Lagerquist,have  read  the  proofs, 
and  aided  me  with  their  criticism. 

HOMER  B.  VANDERBLUE 
NORTHWESTERN  UNIVERSITY 
January,  1917    , 


CONTENTS 

CHAPTER  I.  VALUATION  AND  REGULATION      ....       1 

Introduction:  The  reasonableness  of  rates,  1. 
I.  Valuation  as  a  measure  of  reasonableness,  7. 

History  of  the  doctrine,  7.  —  The  regulation-condemnation    1 
analogy,  9.  —  Ames  v.  Union  Pacific,  12. 

II.  "Fair  value,"  15. 

The  "rule"  in  Smyth  c.  Ames,  16.  —  Market  value,  19.  — 
Capitalization,  22.—  Cost,  22.  — The  Valuation  Act  of  1913, 

24. 

CHAPTER  II.  PHYSICAL  VALUATION  — "CosT  OP  RE- 
PRODUCTION"—  LAND 28 

Introduction:  The  task  of  the  economist,  28. 
I.  "Cost  of  reproduction,"  29. 

Definition,  29.  —  State  and  private  appraisals,  30.    ) 

II.  The  "reproduction"  of  land,  32. 

The  land  multiple,  33.  —  State  experience,  34. 

HI.  The  "true  value"  of  land,  37. 

The  "expert"  method,  38.  —  The  "sales"  method,  40.  — 
The  "sales  and  assessment"  method,  41.  —The  Minnesota 
Rate  Cases,  and  land  valuation,  41.  —  The  railroad  appraisals, 
45. 

CHAPTER  HI.  PHYSICAL  VALUATION  —  "  COST  OF  RE- 
PRODUCTION"—  CAPITAL  GOODS 47 

Introduction:  The  "contingencies"  allowance,  47. 
I.  The  appraisal  of  plant,   50. 

Practice  in  the  State  and  private  "valuations,"  51.  —  Task 
of  classification  of  units,  56.  —  Judgment,  59. 

II.  Unit  prices,  61. 

Expert  opinion,  61.  —  Future  prices,  63.  —  Average  prices, 
65.  —  Units  out  of  the  market,  68.  —  "Average"  units,  70. 

III.  Overhead  charges,  73. 

Average  percentages,  73.  —  "Research,"  74.  —  Interest 
during  construction,  76. 


rii  CONTENTS 

IV.  Deduction  for  depreciation  accrued,  78. 

Obsolescence,  78.  —  Inspection,  80.  — Life  tables,  81.— 
Specious  accuracy,  84. 

CHAPTER  IV.  PHYSICAL  VALUATION  —  "  COST  OF  RE- 
PRODUCTION" (concluded) 85 

Introduction:  The  test  of  certainty,  85. 
I.  The  "cost  of  reproduction"  hypothesis,  85. 

Agricultural  land,  86.  —  Urban  land,  87.  —  Terminals,  89. 
—  The  Minnesota  Rate  Cases,  90.  —  Capital  goods,  94. 

II.  "Cost  of  reproduction"  and  reasonableness,  96. 

Courts  and  Commissions,  97.  —  The  engineers,  97.  —  The 
private  interest,  101.  —  "  Cost  of  reproduction"  and  the  "long 
run"  cost  of  producing  transportation  service,  102. 

CHAPTER  V.  PHYSICAL  VALUATION  —  UNIMPAIRED  IN- 
VESTMENT   108 

Introduction:  Maintenance  of  the  investment,  108. 
[   I.  Investment  and  the  creation  of  capital  goods,  110. 

Depreciation  and  replacement,  110.  —  "Maintenance"  as 
the  creation  of  capital  goods,  111.  —  Charging  plant  to  operat- 
ing expense,  114.  —  The  surplus,  115. 

II.  Depreciation  as  an  operating  cost,  117. 

The  depreciation  reserve  not  a  fund  for  replacements,  1 17.  —  ^ 
The  permanent  depreciation  reserve,  119.  —  Deduction  for   i 
accrued  depreciation,  120.  —  Innocent  holders  and  vested 
interests,  121.  —  The  "simple"  and  "composite"  property 
theory,  122. 

III.  Land,  the  indestructible  element,  124. 

Original  cost,  and  the  "unearned  increment,"  125.  —  The 
Supreme  Court  opinions,  126.  —  The  alienation  argument,  129. 
—  The  discrimination  argument,   130.  —  Unearned  income  j 
essential  for  an  "unearned  increment,"  130. 

IV.  Appraisal  of  unimpaired  investment,  135. 

Depreciated  cost  of  the  units  in  place,  136.  —  Experience  of 
the  Interstate  Commerce  Commission,  136. — Inability  to 
measure  unimpaired  investment  not  a  reason  to  use  "cost  of 
reproduction,"  138.  —  Possible  usefulness  of  the  Federal  Val- 
uation challenged,  139. 


CONTENTS  xiii 

CHAPTER  VI.  THE  INTANGIBLE  ELEMENTS  OF  "FAIR 

VALUE" 141 

Introduction:  The  regulation-condemnation  analogy,  141. 
I.  Franchise  value,  142. 

The  railroad  franchise,  142.  —  Condemnation  proceedings, 
143.  —  Taxation,  144. —  The  analogy  once  more,  145.— 
Alabama  Rate  Cases,  147. 

II.  Strategic  value,  149. 

The  market  value  test  of  the  Washington  Commission, 
150.  —  Operating  conditions,  151.  —  The  railway  value  of 
land,  153. 

III.  Going  value,  159. 

"Going  value"  and  "good-will,"  159.  —  The  comparative 
plant,  160.  —  The  rule  of  C.C.C.  &  St.L.  Ry.  Co.  c.  Backus, 
163.  —  Appraisal  of  "going  value,"  164. 

IV.  The  Wisconsin  theory  of  cost,  166. 

Deficits  below  a  fair  return,  166.  —  The  Western  Advance 
Case  of  1910, 167.  —  The  surplus,  171.  —  "  Reasonable  "  def- 
icits, 174.  —  The  assumption  of  risk,  175. 

V.  The  "cost"  of  business  connections,  and  of  creating  an  organi- 
zation, 177. 

The  New  Jersey  Case,  177.  —  Abandoned  plant  as  the 
"cost  of  progress,"  180.  —  Selling  costs  as  investment,  183. 

CHAPTER  VII.  THE  RETURN  TO  THE  RAILROAD  ...    188 

The  rate  of  return  as  considered  by  the  Commission,  188.  — 
By  the  courts,  190. —  The  legal  rate  of  interest,  191.— 
Willcox  v.  Consolidated  Gas  Co.,  191.  —  The  "risk  element," 
192.  —  The  incidence  of  a  shifting  price  level,  194.  —  Railroad 
credit,  194. —  "Unproductive"  improvements,  195.  —  The 
creation  of  economic  rent,  200.  —  The  differential  element  in 
profits,  202.  — The  "unearned  increment"  once  more,  203. 

BIBLIOGRAPHY 207 

INDEX    ,  217 


RAILROAD  VALUATION 

CHAPTER  I 

VALUATION   AND    REGULATION 

Introduction:  The  reasonableness  of  rates,  1. 
I.  Valuation  as  a  measure  of  reasonableness,  7. 

History  of  the  doctrine,  7. —  The  regulation-condemnation  an- 
alogy, 9.  —  Ames  v.  Union  Pacific,  12. 
II.  "Fair  value,"  15. 

The  "rule"  in  Smyth  v.  Ames,  16.  —  Market  value,  19.  —  Capi- 
talization, 22.  —  Cost,  22.  —The  Valuation  Act  of  1913,  24. 

"ALL  charges  for  any  service  rendered,  or  to  be  rendered, 
in  the  transportation  of  passengers  or  property  shall  be 
just  and  reasonable."  In  this  language  the  Interstate 
Commerce  Act  restates  the  doctrine  of  the  English  Com- 
mon Law.1  But  no  standard  of  reasonableness  is  stated, 
still  less,  imposed.  The  Act  leaves  with  the  Interstate 
Commerce  Commission  the  duty  of  developing  a  body  of 
principles  governing  the  reasonableness  of  rates. 

The  Commission  feels  this  responsibility  in  two  distinct 
ways.  An  individual  charge  may  be  in  question,  or  the 
reasonableness  of  the  return  to  the  carrier  upon  the  total 
business  done.  The  latter  aspect  of  the  problem  is  the  one 
here  to  be  considered.  Though  the  Commission  has,  on 
occasion,  protested  that  its  authority  is  "limited  to  inquir- 
ing into  the  reasonableness  of  a  particular  rate  or  rates,  and 
establishing  the  rate  or  practice  which  is  found  lawful  in 
place  of  the  one  condemned  as  unlawful,"  2  the  adequacy  of 
the  total  return  to  the  railroad  has  been  an  issue  under  two 
sets  of  circumstances:  when  reduction  of  groups  of  rates 

1  I.C.C.  v.  C.N.O.  &  T.P.  Ry.  Co.,  167  U.S.  479,  493. 
1  Eastern  Advance  Case  of  1910,  20  I.C.C.  243,  248. 


9.  RAILROAD   VALUATION 

has  been  in  contemplation  in  response  to  appeal  by  ship- 
pers;l  and  when  tariffs  containing  important  advances  have 
been  filed  by  the  carriers.2 

An  alleged  insufficiency  of  income  has,  indeed,  been  the 
principal  ground  on  which  the  railroads  have  attempted  to 
justify  general  advances  sought.  In  the  Five  Per  Cent 
Case,  a  difference  of  opinion  developed  within  the  Com- 
mission because  of  this  fact,  though  all  members  agreed 
that  the  net  operating  revenue  of  the  roads  in  Official 
Classification  Territory,  "considered  as  a  whole,"  was 
smaller  than  was  demanded  in  the  public  interest 3  —  a 
finding  which,  however,  cannot  be  said  to  have  furnished 
the  key  to  the  original  decision.  For,  though  the  insufficiency 
of  revenue  was  determined  by  a  study  of  the  conditions  of 
the  Trunk  Line,  as  well  as  of  the  Central  Freight  Associa- 
tion roads,  advances  were  permitted  only  within  the  latter 
Territory.  The  explanation  for  this  discrimination  rested 
in  other  considerations  than  those  of  revenue.  "  No  effort 
was  made  on  the  part  of  any  of  the  lines  in  Official  Classi- 
fication Territory  to  show  by  what  may  be  denominated 
rate  testimony  that  the  scale  of  through  rates  is  unduly 
low,  or  that  higher  through  rates  would  be  just  and  reason- 

1  See  especially  the  series  of  " Intermountain  Cases":  Spokane  v.  N.P. 
Ry.  Co.,  15  I.C.C.  376;  19  I.C.C.  162, 173;  Commercial  Club  of  Salt  Lake 
City  v.  A.T.  &  S.F.  Ry.,  19  I.C.C.  218;  Railroad  Commission  of  Nevada 
v.  S.P.  Co.,  19  I.C.C.  238. 

The  same  problem  appeared,  though  in  slightly  different  form,  since 
only  singlecom  modities  were  concerned,  in  Boileau  v.  P.  &  L.E.  R.R. 
Co.,  22  I.C.C.  640  (coal);  Pittsburgh  Vein  Operators  Association  v. 
Penn.  Co.,  24  I.C.C.  280  (coal);  Sheridan  C.  of  C.  v.  C.B.  &  Q.  R.R. 
Co.,  28  I.C.C.  250  (coal);  Lum  v,  G.N.  Ry.  Co.,  33  I.C.C.  541  (iron 
ore);  Pulp  &  Paper  Mfrers.  Association  v.  C.M.  &  St.P.  Ry.,  34  I.C.C. 
500  (pulp  wood). 

2  In  the  Matter  of  Advances,  etc.,  9  I.C.C.  382;  Central  Yellow  Pine 
Association  v.  I.C.C.  R.R.  Co.,  10  I.C.C.  505;   Morgan  Grain  Co.  ». 
A.C.L.  R.R.  Co.,  19  I.C.C.  460;  Eastern  Advance  Case  of  1910,  20  I.C.C. 
243;  Western  Advance  Case  of  1910,  20  I.C.C.  307;  The  Five  Per  Cent 
Case,  31  I.C.C.  350;  32  I.C.C.  325;  The  1915  Western  Advance  Case, 
35  I.C.C.  497;  Western  Passenger  Fare  Case,  37  I.C.C.  1. 

»  31  I.C.C.  350,  351. 


VALUATION  AND  REGULATION  3 

able."  l  For  the  rates  applying  solely  within  the  Central 
Freight  Association  Territory  such  testimony  had  been 
presented. 

The  character  of  this  testimony  illustrates  what  an  elu- 
sive problem  is  attacked  when  a  definition  of  a  reasonable 
rate  is  attempted.  The  Commission  was  convinced  that 
the  class  rates  controlled  by  the  Central  Freight  Associa- 
tion scale  were  "lower  than  comparable  rates  prevailing 
in  any  part  of  the  country,"  the  level  being  "indeed  so  low 
that  an  increase  of  5  per  cent  would  clearly  not  be  un- 
reasonable." And  the  class  rates  affording  "a  reasonable 
test  for  measuring  the  general  level  of  the  commodity  rates," 
the  Commission  thought  that  the  carriers  operating  in  that 
territory  had  sustained  the  burden  of  showing  that  the 
rates  were  unduly  low,  and  that  an  increase  in  them  of 
5  per  cent  would  be  reasonable.  These  rough  comparisons, 
supplemented  with  the  testimony  that  the  rate  structure 
was  "honeycombed  with  inconsistencies,"  "not  logical," 
"unscientific,"  that  the  Central  Freight  Association  scale 
was  a  "relic  of  barbarism,"  constituted  the  "rate  testi- 
mony" on  which  the  changes  were  approved.2 

At  the  time  the  original  opinion  was  handed  down, 
dissents  were  written  by  Commissioners  McChord  and 
Daniels.  For  the  purpose  of  the  present  discussion  two 
important  lines  of  reasoning  were  developed  in  these  dis- 
senting opinions,  the  one  taking  up  the  relation  of  needed 
revenue  to  advances;  the  other  the  relations  of  rates  in 
Official  Classification  Territory,  inter  se.  Both  opinions 
objected  that  the  majority,  in  confining  approval  to  ad- 

1  From  Chairman  Harlan's  dissent  in  the  supplementary  hearing, 
32  I.C.C.  325,  333.  Mr.  Harlan  wrote  the  original  opinion,  31 1.C.C.  350. 
404. 

2  31  I.C.C.  350,  400,  401,  402.  As  to  brick,  tile,  clay,  coal,  coke,  starch, 
cement,  iron  ore,  and  plaster,  the  testimony  was  such  as  to  constrain  the 
Commission  from  holding  that  the  carriers  had  sustained  their  burden 
under  the  statute  (page  403).  In  the  Supplemental  Opinion,  the  permis- 
sion was  granted  to  increase  rates  except  on  coal,  coke,  and  iron,  32 
I.C.C.  325,  331. 


4  RAILROAD  VALUATION 

vances  within  a  limited  area,  had  broken  down  the  estab- 
lished relationship  of  rates.  Commissioner  McChord  in- 
dicated that,  as  he  saw  the  dictates  of  public  policy,  the 
aim  of  the  Commission  should  be  to  preserve  the  exist- 
ing structure.  That  no  other  expedient  could  be  used  had 
been  assumed  quite  as  a  matter  of  course  by  Commissioner 
Prouty  in  1910. l  But  a  general  increase  of  rates  within  only 
the  Central  Freight  Association  Territory  meant  a  change 
in  the  rate  relationship  as  between  cities  in  that  Territory 
and  cities  in  Trunk  Line  Territory: 

"For  many  years  the  rates  between  these  cities  have  borne 
a  fixed  and  well-understood  relation  to  each  other.  ...  If 
the  rate  from  Pittsburgh  to  Chicago  were  increased  and  no 
change  made  in  the  rate  from  New  York  to  Chicago,  it  is 
obvious  that  the  latter  city  would  obtain  an  advantage  over 
the  former,  with  respect  to  the  rates  in  question,  which  it 
has  never  sought  or  claimed  as  a  matter  of  right,  and  which 
would  perhaps  be  unwarranted  from  the  standpoint  of 
geographical  position.  .  .  .  The  transportation  conditions 
in  the  two  territories  are  not  so  unlike  as  to  indicate  the 
wisdom  of  dissimilar  treatment  of  the  rates  proposed."  * 

Commissioner  Daniels  accepted  the  reasoning  here  set 
forth: 

"There  exists  a  presumption  in  favor  of  interrelations  in 
a  rate  fabric  that  have  long  continued  undisturbed.  .  .  . 
With  a  demonstration  of  inadequate  revenues,  and  with  a 
presumption  in  favor  of  the  propriety  of  the  interrelation 
between  rates  long  in  effect,  an  advance  moderate  in  amount, 
calculated  to  produce  but  a  reasonable  increment  in  earnings, 
and  affecting  all  trade  in  the  same  proportionate  degree,  is  the 
plain  dictate  of  law  and  of  common  sense  in  the  premises."  * 

1  Eastern  Advance  Case  of  1910,  20  I.C.C.  243,  272. 

*  The  Five  Per  Cent  Case,  31  I.C.C.  350,  432-34. 
Commissioner  McChord  also  declared  that  the  majority  opinion  placed 

"traffic  passing  into,  out  of,  or  through  Central  Freight  Association  Ter- 
ritory in  a  privileged  class"  (page  433). 

*  Ibid.,  page  450.    Commissioner  Daniels  would  here  seem  to  be  using 
reasonable  in  a  sense  implying  that  the  advances  were  not  great.  Or  is  his 
reference  to  an  intrinsic  reasonableness  ? 


VALUATION  AND  REGULATION       5 

This  paragraph  supplies  the  key  to  the  Supplemental 
Opinion,  in  which  the  Commission  reversed  itself,  granting 
advances  to  the  Trunk  Lines. 

Commissioners  Harlan  and  Clements  dissented  from  the 
Supplemental  Opinion.  In  substance  the  same  ground  for 
objection  was  expressed  by  both  men.  Commissioner 
Clements  saw  in  the  majority  opinion  "a  new  and  radical 
departure,  and  a  most  serious  and  portentous  step."  He  was 
not  aware  of  any  case  in  which  the  Commission  or  any 
court  had  held  "  that  the  need  by  a  carrier  of  money  was  of 
itself  proof  of  the  reasonableness  of  a  specific  rate,  or  body 
of  rates,  increased  to  meet  such  need."  l  The  first  record  had 
contained  no  evidence  seeking  to  prove  that  the  proposed 
increases,  except  in  Central  Freight  Association  Terri- 
tory, were  "just  and  reasonable"  in  themselves;  and  what 
Commissioner  Harlan  had  originally  thought  a  "  deficiency 
in  proof"  had  not  been  supplied  at  the  later  hearing.2 

But  with  the  merits  of  a  controversy  involving  the  ex- 
tent of  discretionary  power  delegated  by  Congress  to  the 
Commission,  there  is  no  present  concern.  The  issue  in- 
volves legal  not  economic  considerations.  Certainly,  how- 
ever, the  problem  of  determining  upon  the  reasonableness 
of  the  return  to  the  carrier  is  not  one  to  which  may  be 
applied  the  "tests  or  factors  heretofore  deemed  pertinent 
and  necessary  to  the  determination  of  the  reasonableness 
of  a  rate."3  It  is  impossible  to  leave  a  reading  of  the  Five 
Per  Cent  Case  without  the  feeling  that  Commissioners 
Clements  and  Harlan  (in  point  of  service,  the  senior  mem- 
bers of  the  Commission)  had  come  to  look  upon  reasonable- 
ness as  intrinsic,  that  they  had  failed  to  recognize  the  im- 
portance of  the  production  of  transportation  service  at 
joint  cost.4  Reasonableness  is  an  uncertain  quantity  when 

1  32  I.C.C.  325,  337.  2  Ibid.,  page  333. 

1  Commissioner  Clements'  dissent,  32  I.C.C.  325,  337. 

4  Aside  from  the  general  tone  of  Commissioner  Harlan's  opinion,  there 
is  his  use  of  figures,  submitted  by  the  Pennsylvania,  apportioning  in- 
vestment, and  returns,  freight  and  passenger,  etc.,  31  I.C.C.  350,  389. 


6  RAILROAD  VALUATION 

applied  to  the  individual  charges  contained  in  the  railroad 
schedules.  But  however  non-discriminatory  and  non- 
preferential  a  body  of  rates  may  be,  it  can  hardly  be  called 
reasonable  unless  the  normal  return  accrues  in  the  normal 
case.  From  the  economic  point  of  view,  Commissioner 
Daniels'  conclusion  that  "proof  of  inadequate  revenue 
suffices  to  meet  the  burden  cast  by  the  statute  on  carriers 
seeking  the  advance,*5  can  therefore  be  accepted.1 

An  analogous  problem  has  been  presented  to  the  Supreme 
Court.  The  Fourteenth  Amendment  to  the  Constitution 
has  been  held  to  protect,  from  regulation  by  the  States, 
"the  right  of  the  railroads  to  receive  just  compensation  for 
the  service  given  the  public.'*  2  But  a  clear  distinction  has 

1  31  I.C.C.  350,  451,  Commissioner  Daniels'  dissent  (original  opinion); 
see  also  pages  435-36.    The  opinions  by  the  Commission  in  the  1910 
Cases  would  seem,  however,  to  uphold  the  contention  of  Commissioners 
Harlan  and  Clements;  see  especially  Commissioner  Prouty's  opinion  in 
the  Eastern  Case,  20  I.C.C.  243,  249;  and  Commissioner  Lane's  discussion 
of  the  "American  System  of  Railroad  Rate-Making,"  20  I.C.C.  307,  349. 

In  the  1915  Western  Rate  Advance  Case,  the  carriers  based  their 
claims  to  additional  revenue  upon  the  grounds  of  their  financial  needs 
and  the  downward  tendency  of  their  net  revenues  in  the  Western  Trunk 
Line  Territory,  and  contended  that  the  commodities  singled  out  by  them 
to  bear  the  proposed  advances  were  not  carrying  their  equitable  part 
of  the  costs  of  transportation.  35  I.C.C.  497,  500. 

2  Minnesota  Rate  Cases,  230  U.S.  352,  434. 

For  a  history  of  the  doctrine  of  judicial  review,  see  "The  Regulation 
of  Railway  Rates  under  the  Fourteenth  Amendment,"  by  Justice  F.  J. 
Swayze,  of  New  Jersey,  Quarterly  Journal  of  Economics,  volume  26, 
page  389. 

The  courts  have  taken  jurisdiction  on  the  ground  that  "due  process  of 
law"  necessarily  involves  consideration  of  reasonableness  by  the  judiciary 
(C.M.  &  St.P.  Ry.  Co.  v.  Minnesota,  134  U.S.  418).  The  Fifth  Amend- 
ment, which  restrains  the  Federal  Government,  has,  however,  been  in- 
terpreted not  to  demand  judicial  interference,  or  regular  court  proceedings 
(Murray's  Lessee  p.  Hoboken  Land  &  Improvement  Co.,  18  Howard  272), 
though  this  opinion  was  handed  down  in  1855,  forty-five  years  before  the 
opinion  in  C.M.  &  St.P.  Ry.  Co.  c.  Minnesota.  That  the  strength  of  the 
more  recent  precedent  would  result  in  the  rejection  of  the  older  reason- 
ing is  perhaps  a  fair  presumption. 

Yet  to  permit  a  court  to  put  aside  orders  of  the  Interstate  Commerce 
Commission  establishing  reasonable  rates  would  apparently  run  directly 
counter  to  the  doctrine  of  Texas  &  Pacific  Ry.  Co.  c.  Abilene  Cotton  Oil 


VALUATION   AND   REGULATION  7 

been  drawn  between  the  legislative  and  judicial  points  of 
view.  The  Court  can  only  insist  that  the  return  under 
schedules  established  under  legislative  order,  or  through 
the  agency  of  a  commission,  shall  not  be  "so  unreasonably 
low"  as  to  deprive  the  carrier  of  its  property  "  without  due 
process  of  law." l  The  confiscation  doctrine  therefore  sets 
a  minimum.  How  much  more  the  rate  of  return  may  be, 
rests  within  the  range  of  "legislative  discretion."  2 

But  both  the  Court,  seeking  a  measure  of  confiscation, 
and  the  Commission,  seeking  a  measure  of  reasonableness, 
especially  since  the  Court  may  have  occasion  to  pass  upon 
the  decision  of  the  Commission,  should,  it  would  seem,  use 
the  same  standard  of  measurement.  The  incidence  of  the 
viewpoint  of  the  distinct  and  different  bodies  should  be 
upon  the  rate  of  return.  A  reasonable  return  may  well  be 
something  other  than  a  non-confiscatory  return.  In  other 
respects  the  economic  problem  seems  identical. 


It  was  Justice  Harlan  who  first  generalized  that  "the 
basis  of  all  calculations  as  to  the  reasonableness  of  rates 
must  be  the  fair  value  of  the  property  being  used  for  the 
public." 3  But  his  contribution  was  merely  to  put  in  clearer 

Co.,  204  U.S.  426.  Especially  is  this  true  since  the  Supreme  Court,  in 
Northern  Pacific  Ry.  Co.  v.  North  Dakota,  236  U.S.  585,  applied  the 
confiscation  doctrine  to  rates  established  by  State  Governments,  apply- 
ing on  a  single  commodity.  Can  the  rate  on  say  lignite  coal  be  at  once 
"reasonable"  and  "confiscatory"  ? 

1  Minnesota  Rate  Cases,  230  U.S.  352,  433.  See  also  the  fuller  discus- 
sion in  Knoxville  v.  Knoxville  Water  Co.,  212  U.S.  1, 16;  Willcox  v.  Con- 
solidated Gas  Co.,  212  U.S.  19,  41;  Ex  parte  Young,  209  U.S.  123,  166; 
Louisville  ».  Cumberland  T.  &  T.  Co.,  225  U.S.  430,  436.    Even  as  early 
as  Smyth  v.  Ames,  Supplemental  Opinion,  171  U.S.  361,  the  phrase  "so 
unreasonably  low,"  was  used  (page  364). 

2  L.  &  N.  R.R.  Co.  v.  Garrett,  231  U.S.  299,  313.    See  especially  the 
cases  cited  at  page  314. 

3  Smyth  v.  Ames,  169  U.S.  466,  546;  sustaining  Ames  p.  Union  Pacific, 
64  Fed.  165. 


8  RAILROAD  VALUATION 

language  conclusions  already  deduced  by  Justice  Brewer.1 
There  was  nothing  in  the  career  of  either  of  these  men 
which  promised  peculiar  aptitude  for  the  theoretical  and 
technical  issues  necessarily  involved  in  determining  upon 
reasonable  railroad  rates.  In  1894,  the  date  of  his  decision 
in  Ames  v.  Union  Pacific,  Justice  Brewer  had  spent  over 
thirty  years  upon  the  bench,  substantially  his  whole  mature 
lifetime.  Justice  Harlan,  who  four  years  later  wrote  the 
opinion  for  the  Supreme  Court,  had  then  been  a  member 
of  that  Court  for  twenty  years.  As  a  result  both  men  had 
been  shielded  from  participation  in  the  discussion  of  rate 
regulation  which  persisted  in  the  period  after  1870.  So, 
when  the  problem  was  thrust  upon  them  by  the  reversal  of 
the  Granger  Cases,  it  raised  especially  the  question  of  the 
sacredness  of  private  property.  Accordingly,  technical  and 
economic  considerations  gave  way  to  precedents  taken 
from  those  aspects  of  judicial  experience  where  the  issue  of 
vested  interests  was  seen.2 

1  Indeed,  there  is  peculiar  irony  in  finding  these  words  coming  from 
Justice  Harlan.  Some  years  previously  he  had  gone  out  of  his  way  to 
condemn  a  proposed  valuation  test.  The  Mississippi  statute  of  1884, 
which  came  before  the  Court  in  Stone  v.  Farmers'  Loan  &  Trust  Co., 
116  U.S.  307,  directed  the  State  Railroad  Commission  to  revise  the  car- 
riers' tariffs,  permitting  "a  fan*  and  just  return  on  the  value  of  such  rail- 
road, its  appurtenances,  and  equipments"  (page  309).  Chief  Justice 
Waite  ignored  the  clause  entirely  in  his  majority  opinion;  not  so,  Justices 
Harlan  and  Field  who  dissented.  Both  rejected  the  proposed  test  flatly, 
though  its  adequacy  was  not  in  question  before  the  Court,  since  the  State 
Commission  had  been  enjoined  from  establishing  rates.  It  is  clear  that 
they  were  following  the  briefs  for  the  railroads,  that  of  E.  L.  Russell, 
at  page  56,  that  of  James  Fentrees  at  page  27.  See  dissenting  opinions: 
Justice  Field,  page  343;  Justice  Harlan,  page  340,  116  U.S.  307. 

The  "valuation"  test  had  previously  been  presented  to  Justice  Woods 
of  the  Supreme  Court,  in  the  case  of  Tilley  v.  S.F.  &  W.  Ry.  Co.,  5  Fed. 
641,  662.  Justice  Woods,  however,  refused  to  depart  from  the  doctrine 
of  judicial  non-interference  set  up  in  the  Granger  Cases  (94  U.S.  113). 
See  also  L.  &  N.  R.R.  Co.  ».  Railroad  Commission  of  Tennessee,  19 
Fed.  679,  683. 

1  C.M.  &  St.P.  Ry.  Co.  v.  Minnesota,  134  U.S.  418.  In  Chicago  & 
Grand  Trunk  Ry.  Co.  v.  Wellman,  143  U.S.  339,  346,  Justice  Brewer 
emphasized  the  responsibility  of  the  Court,  "While  the  protection  of 


VALUATION  AND   REGULATION  9 

The  result  was  an  attempt  to  draw  an  analogy  between 
condemnation  and  rate  regulation,  the  terms  of  which  were 
never  clearly  stated.  In  Reagan  v.  Farmers'  Loan  and 
Trust  Company,  where  for  the  first  time  a  schedule  of 
rates  was  condemned  as  confiscatory  by  the  Supreme 
Court,  Justice  Brewer  introduced  this  line  of  reasoning. 
Both  rate  regulation  and  exercise  of  the  power  of  eminent 
domain  represent  interference  by  the  public  with  the  un- 
disturbed enjoyment  of  private  property.  In  the  one 
event,  the  income  is  affected,  though  the  title  remains  un- 
disturbed; in  the  other,  title  itself  is  taken.  Now  if  the 
State  were  to  condemn  the  railroad,  "is  there  any  doubt 
that  constitutional  provisions  would  require  the  payment 
to  the  corporation  of  just  compensation,  —  that  compensa- 
tion being  the  value  of  the  property  as  it  stood  in  the 
markets  of  the  world  and  not  as  prescribed  by  an  act  of  the 
legislature?  Is  it  any  less  a  departure  from  the  obligations 
of  justice  to  seek  to  take  not  the  title,  but  the  use  for  the 
public  benefit  at  less  than  its  market  value?"  l  The  ques- 
tion is  confusing.  What  shall  determine  the  market  value 
of  the  "use"?  Or  is  it  the  "value"  of  the  "property"  to 
which  reference  is  made?  From  the  discussion  no  definite 
answer  could  be  made  with  assurance.  But  in  Ames  v. 
Union  Pacific,  Justice  Brewer  referred  to  the  analogy 
which  he  here  hinted,  and,  without  declaring  regulation 
pro  tanto  condemnation,  proceeded  to  argue  upon  that 
basis. 

vested  rights  of  property  is  a  supreme  duty  of  the  courts,"  etc.    See  also 
his  decision  in  C.  &  N.W.  Ry.  Co.  ».  Dey,  35  Fed.  866,  872. 

1  Reagan  v.  Farmers'  Loan  &  Trust  Co.,  154  U.S.  362,  410.  The  Su- 
preme Court  has  never  declared  regulation  and  condemnation  analogous. 
Justice  Brewer  merely  argued  as  though  they  were  analogous.  The  lower 
courts  (e.g.,  Spring  Valley  W.W.  v.  San  Francisco,  124  Fed.  574,  594; 
Kings  County  Lighting  Co.  v.  Willcox,  156  App.  Div.  N.Y.  603,  606) 
have,  however,  gone  the  full  way.  See  Brief  of  Messrs.  Dunlap,  Norton  and 
Lathrop  for  the  Santa  Fe,  Evidence,  In  the  Matter  of  Proposed  Advances 
(1910).  Senate  Document  725,  61st  Congress,  3d  Session,  page  3602, 
hereafter  cited  simply  as  "Evidence,  1910  Advances." 


10  RAILROAD   VALUATION 

"Property  invested  in  railroads,"  he  declared,  "is  as 
much  protected  from  appropriation  as  any  other.  If  taken 
for  public  uses,  its  value  must  be  paid  for.  Constitutional 
guaranties  to  this  extent  are  explicit.  .  .  .  The  value  of 
property  cannot  be  destroyed  by  legislation  depriving  the 
owner  of  adequate  compensation.  .  .  .  The  protection  of 
property  implies  the  protection  of  its  value."  Indeed,  "if 
the  public  was  seeking  to  take  title  to  the  railroad  by  con- 
demnation, the  present  value  is  that  which  it  would  have  to 
pay.  In  like  manner,  it  may  be  argued  that,  when  the  legis- 
lature assumes  the  right  to  reduce,  the  rates  so  reduced 
cannot  be  adjudged  unreasonable  if  under  them  there  is 
earned  a  fair  interest  on  the  actual  value  of  the  property."  l 
This  train  of  reasoning  Justice  Harlan  did  not  repeat. 
Instead  he  simply  declared  the  railroad  entitled  to  earn  a 
"fair  return"  upon  the  "fair  value"  of  the  property,  pro- 
vided this  could  be  secured  from  rates  reasonable  to  the 
public.2  This  holding,  like  Justice  Brewer's  "that  which 

1  64  Fed.  165,  176,  177.  The  italics  are  the  writer's. 

8  Smyth  v.  Ames,  169  U.S.  466,  547. 

A  supplementary  opinion,  seldom  cited,  held:  "The  general  question 
argued  before  us  on  the  original  hearing  was  whether  the  rates  ...  as  an 
entirety,  were  so  unreasonably  low  as  to  prevent  the  railroad  companies 
from  earning  such  compensation  as  would  be  just,  having  due  regard 
both  to  the  rights  both  of  the  public  and  of  the  companies.  .  .  .  We  did 
not  intend  ...  to  adjudge  that  the  railroad  companies  should  not,  if  they 
saw  proper,  reduce  the  rates,  or  any  of  them,  under  which  they  were 
conducting  business  .  .  .  nor  that  the  State  Board  .  .  .  should  not 
reduce  rates.  ...  It  may  well  be  that  on  some  particular  article  rail- 
road companies  may  deem  it  wise  to  make  a  reduction  of  the  rate,  and 
it  may  be  that  the  public  interests  will  justify  the  State  Board  of  Trans- 
portation in  ordering  such  reduction.  We  have  not  laid  down  any  cast- 
iron  rule  covering  each  and  every  separate  rate.  ...  If  the  State  should 
by  statute,  or  through  its  board  of  transportation,  prescribe  a  new 
schedule  of  rates  covering  substantially  all  articles  and  which  would 
materially  reduce  those  charged  by  the  companies  respectively,  or  should, 
by  reduction  of  rates  on  a  limited  number  of  articles,  make  its  schedule 
of  rates  as  a  whole,  produce  the  same  result,  the  question  will  arise  whether 
such  rates,  taking  into  consideration  the  rights  of  the  public,  as  well  as 
the  rights  of  the  carriers,  are  consistent  with  the  principles  announced 
by  this  court  in  the  opinion  heretofore  delivered."  Smyth  ».  Ames,  171 
U.S.  361,  364,  365. 


VALUATION   AND  REGULATION  11 

is  unjust  cannot  be  reasonable,"  l  seemingly  begged  the 
whole  question. 

These  guarded  statements  may  be  taken  as  indicating 
the  reluctancy  of  the  mood  in  which  the  Court  approached 
the  problem  over  which  it  had  taken  jurisdiction  so  tardily. 
The  Court  was  feeling  its  way,  careful  always  to  announce 
that  each  case  must  be  considered  by  itself.2  Indeed,  had 
there  been  attempt  at  careful  formulation  and  applica- 
tion of  the  "valuation"  standard,  —  or  need  for  it,  —  the 
doctrine  must  have  been  abandoned  long  before  reaching 
the  dignity  of  a  precedent.  For  a  "fair  value"  test  of 
reasonableness  (if  by  "value"  is  meant  "exchange  value," 
which,  it  would  seem,  is  what  Justice  Brewer  had  in 
mind)  involves  arguing  in  a  circle.3  The  analogy  between 
condemnation  and  regulation  is  premised  upon  the  condi- 
tion that  lower  rates  will  reduce  earning  power,  and,  pari 
passu,  the  value  of  the  property.  How  else  justify  the 
analogy  at  all?  But  to  test  rates  by  the  value  of  the 
property  before  the  act  of  regulation  is  made  effective 
means  the  abandonment  of  regulation.  And  to  test  them 
by  the  value  of  the  property,  once  the  new  schedules  are 
in  effect,  means  the  approval  of  any  schedule  that  may 
be  established.  The  vicious  circle  is  clearly  present.4 

Yet  it  cannot  be  said  that  Justice  Brewer  appeared  to 
appreciate  the  difficulty.  In  part  this  was  due  to  the 
general  tone  of  his  argument;  in  part  it  was  due  to  the 

1  Ames  v.  Union  Pacific,  64  Fed.  165,  176. 

2  This  reservation  appears  also  in  the  Minnesota  Rate  Cases,  230  U.S. 
352,  434. 

3  The  Commission  has  recognized  this  fact.  In  the  Matter  of  Advances, 
etc.,  9  I.C.C.  382,  403  (1903).   Justice  Brewer's  theory  of  valuing  fixed 
capital  involved  a  capitalization  of  earning  power,  though  he  nowhere 
made  a  clean-cut  statement  of  principle.   Monongahela  Navigation  Co. 
v.  U.S.,  148  U.S.  312;  C.C.C.  &  St.L.  Ry.  Co.  v.  Backus,  154  U.S.  439; 
The  Express  Cases,  166  U.S.  185. 

4  The  "circle"  in  the  "valuation"  test  was  noticed  in  Cotting  v. 
Kansas  City  S.Y.  Co.,  82  Fed.  850,  854.  It  was  also  cited  by  J.  D.  Works 
in  San  Diego  L.  &  T.  Co.  v.  Jasper,  174  U.S.  739,  Brief  for  the  Company, 
page  10. 


12  RAILROAD   VALUATION 

peculiar  facts  of  the  cases  in  which  he  conceived  of  the 
analogy,  and  suggested  the  "value"  test.  In  the  Reagan 
Case,  the  road  concerned,  the  International  and  Great 
Northern,  was  in  the  receiver's  hands.  It  had  never  paid 
a  dividend  and  the  stockholders  had  even  been  assessed  to 
meet  the  charges  on  the  bonds.  The  bondholders  had  been 
forced  to  fund  accrued  and  defaulted  interest  in  junior 
securities.  Yet  the  stocks  and  bonds  originally  issued 
($25,000,000),  according  to  the  figures  which  the  Court 
accepted,  "represented  value."  The  Supreme  Court 
opinion  simply  held  that  rates  already  insufficient  should 
not  be  further  reduced.  There  was  no  discussion  of  how  the 
"value"  of  the  road  was  determined,  or  what  was  the  rela- 
tionship of  rates  to  that  "value."  In  fact,  though  reduc- 
tions in  rates  were  assumed  to  reduce  "value"  in  one  por- 
tion of  the  decision,  elsewhere  the  Court  reasoned  as  if 
"value"  were  intrinsic.1 

Similarly  the  "facts"  accepted  by  Justice  Brewer  in 
Ames  v.  Union  Pacific,  which,  from  one  viewpoint,  might 
have  been  expected  to  indicate  the  circle  in  the  "value" 
test,  in  fact  eliminated  the  necessity  of  fixing  upon  "  the 
actual  value."  For  it  was  held  by  both  Justices  Brewer  and 
Harlan  that  the  reduction  in  rates  would  generally  have 
meant  no  contribution  by  intrastate  traffic  to  payments  of 
interest  on  bonds,  or  dividends  on  stock.2 

The  unpreparedness  of  the  Court  to  sift  the  evidence 
critically  is  indicated  by  the  quality  of  that  evidence. 
Calculations  offered  were  accepted  without  that  spirit  of 
challenging  skepticism  found  in  the  decisions  of  a  later 
day.3  But  the  onus  must  rest  less  upon  the  Court  than  upon 

1  154  U.S.  362,  410,  411. 

2  Ames  v.  Union  Pacific,  64  Fed.  165,  186,  187;  Smyth  v.  Ames,  169 
U.S.  466,  543. 

8  The  best  expression  of  this  critical  attitude  is  found  in  Justice 
Holmes'  opinion  in  the  Louisville  Telephone  Case,  225  U.S.  430,  436. 
See,  however,  Northern  Pacific  Ry.  Co.  v.  North  Dakota,  236  U.S.  585; 
Norfolk  &  Western  Ry.  Co.  t;.  Conley,  236  U.S.  605. 


VALUATION  AND   REGULATION  13 

the  attorneys  for  the  State,  and  their  "expert"  witness, 
"a  gentleman,"  in  Justice  Brewer's  phrase,  "whose  com- 
petency and  credibility"  were  "unchallenged."  "From 
the  labyrinth  of  tables,  figures,  and  estimates  presented  in 
the  testimony"  the  Court  selected  tables  prepared  by  the 
Secretary  of  the  Nebraska  Board  of  Transportation,  as 
"the  basis  for  some  fair  calculations."  l  The  amount  of 
income  received  from  local  freight  business  in  the  three 
years,  1891,  1892,  and  1893,  was  accepted  as  reported  by 
the  carriers  to  the  State  Board,  and  the  reduction,  had  the 
rates  prescribed  by  law  been  in  effect  during  those  years, 
was  determined  by  deducting  29.5  per  cent  from  these 
amounts.2 

This  29.5  per  cent  was  the  unweighted  arithmetical 
average  of  the  percentage  reductions  in  each  of  the  ten 
classes  of  traffic,  for  which  rates  were  prescribed  by  law. 
Not  only  was  there  a  wide  spread  in  the  figures  which  were 
averaged  (the  deduction  in  Class  E  rates  being  the  lowest, 
19  per  cent,  that  in  Class  5  being  the  highest,  35  per  cent), 
but  the  witness  testified  that  the  reduction  in  rates  on  live 
stock,  wheat,  flour,  and  grain,  "locally  the  principal 
items,"  had  been  only  14  per  cent,  etc.3  In  the  face  of  this 
testimony  the  "average  reduction"  was  made  for  all  roads 
in  each  year,  though  the  distribution  of  traffic  from  year 
to  year  on  each  road,  even  assuming  that  all  traffic  was 
handled  under  the  class  rates,  could  hardly  have  been 
uniform.  This  erroneous  analysis  was  followed  by  the 

1  64  Fed.  165,  179. 

2  64  Fed.  165,  187.  For  a  discussion  of  the  expedient  of  making  calcu- 
lations on  the  basis  of  previous  business,  see  H.  S.  Smalley,  Railroad  Rate 
Control,  page  60.    Professor  Smalley  did  not,  however,  indicate  the  re- 
markable process  by  which  the  figure  of  29.5  per  cent  was  secured. 

8  Testimony  of  Mr.  Dilworth,  the  Secretary  of  the  State  Board, 
Record,  Ames  v.  Union  Pacific  (Smyth  v.  Ames,  169  U.S.  466),  page  398; 
see  page  637.  The  figures  which  were  averaged  were  the  following  per- 
centage reductions:  First  Class,  30;  Second,  27;  Third,  26;  Fourth,  29; 
Fifth,  35;  Class  A,  32;  B,  34;  C,  32;  D,  31;  E,  19; —  an  average  (ten 
classes),  of  29.5  per  cent. 


14  RAILROAD  VALUATION 

attorneys  for  the  State,  and  therefore  naturally  enough 
by  both  Justices  Brewer  and  Harlan.1 

That  the  assumed  reduction  of  29.5  per  cent  in  the  rates 
would  have  lessened  the  "value"  of  the  railroad  seems 
not  to  have  been  considered.  There  was  no  attempt  to  bring 
together  the  analogy  between  regulation  and  condemna- 
tion, and  the  hypothesis  which  insisted  upon  the  effect 
of  reductions  as  lessening  earnings,  since  the  volume  of 
traffic  was  not  conceived  of  as  increased. 

Justice  Holmes,  indeed,  once  barely  avoided  the  logical 
trap  set  by  the  "valuation"  doctrine,  when,  in  Knoxville 
Water  Company  v.  Knoxville,  the  complainants  alleged 
that  a  rate  reduction  had  been  made  in  order  to  cut  down 
the  value  of  the  plant  preliminary  to  public  purchase.2 
If  this  plea  were  accepted,  and  "value"  maintained  as  a 
test  for  both  purposes  of  regulation  and  condemnation, 

1  Brief  of  J.  L.  Webster  for  the  State,  pages  18,  84.  Ames  v.  Union 
Pacific,  64  Fed.  165,  183;  Smyth  v.  Ames,  169  U.S.  466,  535. 

No  more  sound  was  the  calculation  of  expenses.  Justice  Brewer  took 
the  Nebraska  operating  ratio,  which  covered  both  passenger  and  freight 
operations;  assumed  that  the  ratio  on  Nebraska  intrastate  business  would 
exceed  the  general  operating  ratio  on  all  business  "  probably  10  per  cent 
up  to  20  per  cent"  —  possibly  higher,  though  this  amount  was  "not 
like"  the  calculation  of  the  effect  of  reduction  of  rates  on  earnings, 
"where  the  figures  and  per  cents"  were  "accurate  and  certain,"  etc. 
64  Fed.  165,  182-86. 

Justice  Harlan  insisted  on  adding  10  per  cent  to  the  operating  ratio  to 
show  "due  regard"  to  the  testimony  (that  of  Mr.  Dilworth,  and  of  Mr. 
Henry  Fink),  the  Court's  only  "basis  for  judgment."  He  then  drew  up  a 
table  to  show  "at  a  glance"  the  effect  of  the  rates  under  consideration. 
For  example,  the  Burlington  road  in  1892  had  an  operating  ratio  of 
64.23  per  cent  (this  figure  appears  also  in  the  Statistics  of  Railways  for 
that  year,  page  385).  Adding  10  per  cent  to  cover  the  extra  cost  of  doing 
intrastate  business,  though  both  interstate  and  intrastate  business  were 
handled  on  the  same  trains,  and  though  the  intrastate  rates  were  on  a 
higher  level,  a  cost  figure  of  74.23  per  cent  was  secured.  Since  earnings 
had  been  reduced  to  70.50  per  cent  of  their  former  level,  an  operating 
loss  equal  to  3.73  per  cent  of  the  former  intrastate  earnings  was  calculated. 
169  U.S.  466,  530-36.  Similar  calculations  are  found  in  N.P.  Ry.  Co.  v. 
Keyes,  91  Fed.  47,  55. 

z  189  U.S.  434. 


VALUATION  AND  REGULATION  15 

regulation  must  cease.  Any  reduction  in  rates,  other  things 
remaining  the  same,  would  lower  the  value  of  the  property 
which  must  be  the  measure  of  reasonableness.  Consciously 
or  unconsciously  the  Court  begged  the  question:  "We  may 
assume  with  the  Supreme  Court  of  Tennessee  that  if  the 
rates  were  reduced  unreasonably,  a  judicial  remedy  would 
be  found.  We  may  assume  further  that  an  attempt  to 
affect  the  price  of  the  company's  plant  in  that  way,  if  the 
city  should  elect  to  purchase,  would  not  be  allowed  to  suc- 
ceed." 1  And  later,  in  a  rate  case,  referring  to  this  passage 
Justice  Holmes  added,  "of  course,  as  we  indicated  the 
other  day  ...  if  an  attempt  were  made  to  cut  down 
values,  by  the  reduction  of  rates,  the  courts  would  know 
how  to  meet  it."  2  These  two  citations,  which,  it  would 
seem,  evade  the  issue,  can  hardly  be  explained  except  on 
the  ground  that  the  Court  was  reasoning  (unknowingly, 
to  be  sure)  without  regard  to  the  vicious  circle.  At  all 
events,  in  the  Minnesota  Rate  Cases,  Justice  Hughes,  in 
an  opinion  otherwise  remarkable  for  its  original  and  clean- 
cut  thinking,  could  pass  over  the  difficulty  with  the  use  of 
citations.3 


II 

But,  if  the  capitalization  of  earnings  be  rejected,  what 
rules  do  govern  the  determination  of  "fair  value"?  None 

1  189  U.S.  434,  438.    The  italics  are  the  writer's. 

2  San  Diego  L.  &  T.  Co.  ».  Jasper,  189  U.S.  439,  443. 

8  230  U.S.  352,  434.  The  perpetuation  of  the  "valuation"  test  by  the 
Supreme  Court  can  in  part  be  ascribed  to  the  accident  that  a  California 
statute  directed  certain  local  bodies  having  control  over  water  rates  to 
"estimate  as  nearly  as  may  be  the  value,"  etc.  In  San  Diego  L.  &  T.  Co. 
v.  Jasper,  189  U.S.  439,  Justice  Holmes  identified  this  provision  with  the 
"value"  rule  of  the  Supreme  Court  (page  442).  See  also  San  Diego  L.  & 
T.  Co.  v.  National  City,  174  U.S.  739,  757;  and  Stanislaus  County  v.  S.J. 
&  K.R.  Canal  Co.,  192  U.S.  201,  215.  This  series  of  cases  Justice  Hughes 
cited,  together  with  Knoxville  v.  Knoxville  Water  Co.,  212  U.S.  1,  and 
Willcox  v.  Consolidated  Gas  Co.,  212  U.S.  19,  which  were  based  upon 
the  Smyth  v.  Ames  decision  and  the  California  cases. 


16  RAILROAD  VALUATION 

—  "the  ascertainment  of  that  value  is  not  controlled  by 
artificial  rules.  It  is  not  a  matter  of  formulas,  but  there 
must  be  a  reasonable  judgment  ...  of  all  relevant  facts." 
With  these  words  Justice  Hughes  took  up  the  problem  in 
the  Minnesota  Rate  Cases.1  Yet  so  long  as  "reasonable" 
qualifies  the  scope  of  judgment,  as  well  as  the  "value" 
sought  for,  it  can  hardly  be  said  that  the  Supreme  Court 
has  ever  committed  itself  to  the  "valuation"  test  in  un- 
equivocal language.  Certainly  "exchange"  value  is  not 
meant. 

Justice  Hughes,  indeed,  subscribed  to  an  inquiry  the  scope 
of  which  was  "thus  broadly  described"  in  Smyth  v.  Ames: 

"In  order  to  ascertain  that  value  the  original  cost  of  con- 
struction, the  amount  expended  in  permanent  improvements, 
the  amount  and  market  value  of  its  bonds  and  stock,  the 
present  as  compared  with  the  original  cost  of  construction, 
•the  probable  earning  capacity  under  particular  rates  pre- 
scribed by  statute,  and  the  sum  required  to  meet  operating 
expenses,  are  all  matters  for  consideration,  and  are  to  be 
given  such  weight  as  may  be  just  and  right  in  each  case. 
We  do  not  say  that  there  may  not  be  other  matters  to  be 
regarded  in  estimating  the  value  of  the  property.  What  the 
company  is  entitled  to  ask  is  a  fair  return  upon  the  value  of 
that  which  it  employs  for  the  public  convenience.  On  the 
other  hand,  what  the  public  is  entitled  to  demand  is  that  no 
more  be  exacted  from  it  for  the  use  of  a  public  highway  than 
the  services  rendered  by  it  are  reasonably  worth."  2 

Clearly  this,  the  "rule,"  "the  judgment  of  the  Supreme 
Court  of  the  United  States,"  3  has  been  received  too  seri- 
ously. Whoever  shall  make  a  "reasonable  judgment"  of 
the  "fair  value"  must  take  into  account  a  series  of  irre- 
concilable forces:  investment,  "cost  of  reproduction,"  the 

1  230  U.S.  352,  4345   In  the  fifteen  years  1898-1913,  no  railroad  case 
involving  "value"  as  an  issue  had  come  to  the  Supreme  Court.  Thus  the 
Minnesota  Rate  Cases  looked  back  to  Smyth  v.  Ames. 

2  169  U.S.  466,  546,  quoted,  230  U.S.  352,  434. 

8  Eastern  Advance  Case  of  1910,  20  I.C.C.  243,  256.  Commissioner 
Prouty  also  here  referred  to  the  paragraph  quoted  as  "the  law  .  .  .  never 
...qualified"  (page  257). 


VALUATION  AND  REGULATION  17 

commercial  valuation,  the  probable  net  earnings  —  even 
any  other  facts  which  he  may  believe  relevant.  The  result- 
ant is  the  "reasonable  value." *  The  impossibility  of  mak- 
ing practical  use  of  the  "rule"  appeared  when  first  such 
attempt  was  made.  In  Chicago,  Milwaukee  and  St.  Paul 
Railway  v.  Tompkins,  Judge  Garland  quoted  Justice 
Harlan,  continuing:  "Here  is  the  rule,  and  the  only 
question  for  the  Court  now  to  ascertain  is,  what  is  the  fair 
value  of  the  railroad  property."  After  hearing  a  mass  of 
contradictory  testimony  on  "  cost  of  reproduction,"  which 
was  "not  less  than  cost,"  the  amount  and  the  market 
value  of  the  stocks  and  bonds,  etc.,  the  Court  found 
that  the  only  way  to  fix  the  "  reasonably  fair  value  "  of  the 
complainant's  property  was  "by  estimating,  by  guess- 
ing." So  Judge  Garland  made  his  "guess." 2 

Instead  of  stating  a  "rule,"  expressing  a  "judgment," 
the  truth  is  rather  that  Justice  Harlan,  to  avoid  committing 
the  Court  to  a  single  standard  of  "value,"  — it  must  be 
remembered  that  the  task  of  determing  upon  "fair  value" 
was  not  faced  in  Smyth  v.  Ames  and  that  the  "rule" 
represents  mere  dicta,  —  included  every  element  which 
entered  into  the  record  of  the  case  at  any  point.  The 
amount  of  the  investment  had  been  urged  by  the  attorneys 
of  the  Union  Pacific  as  the  basis  upon  which  to  calculate 
a  "fair  return."  3  Or  as  an  alternative  they  suggested  the 
amount  of  the  outstanding  capitalization.4  "Cost  of  re- 

1  "The  reasonable  value  of  the  property  is  not  determined  by  the 
amount  of  outstanding  bonds,  the  amount  of  stock,  the  replacement  value, 
nor  by  the  earning  capacity,  but  is  determined  by  a  consideration  of  these 
elements  in  the  evidence  when  their  bearing  on  the  question  of  value  is 
fairly  considered."    Judge  Clark,  Knoxville  Water  Co.  v.  Knoxville, 
page  296,  Record,  Knoxville  v.  Knoxville  Water  Co.,  212  U.S.  1. 

2  90  Fed.  363,  369.   The  Brief  of  G.  R.  Peck  and  A.  B.  Kittredge  on 
appeal,  objecting  to  the  lower  court's  "  guess,"  spoke  of  the  "  rule  laid 
down  by  this  court  in  Smyth  v.  Ames."    Brief  for  the  railroad,  page  12, 
C.M.  &  St.P.  Ry.  v.  Tompkins,  176  U.S.  167. 

8  Ames  v.  Union  Pacific,  64  Fed.  165,  177. 

*  Smyth  v.  Ames,  169  U.S.  466,  544.  See  Argument  of  W.  J.  Bryan, 
page  489  and  following. 


18  RAILROAD   VALUATION 

production"  (which  was  below  the  "values'*  suggested  by 
the  roads)  was  the  standard  proposed  by  the  State. 
"There  is  only  one  true  rule  to  go  by,"  it  was  urged;  "rail- 
road property  must  be  valued  as  all  other  kinds  of  property, 
at  what  it  would  cost  to  reproduce  the  road,  or  one  simi- 
larly situated."  The  burden  of  "injudicious  contracts, 
poor  engineering,  rascality  "  should  rest  upon  the  railroad. l 
No  evidence  bearing  on  the  market  value  of  the  securities 
appeared  in  the  record,  and  its  inclusion  is  an  addition 
made  by  Justice  Harlan.  The  inquiry  concerning  probable 
earning  capacity  and  operating  expenses  may  be  fairly 
assumed  to  have  led  the  Court  to  identify,  for  the  moment, 
the  process  of  determining  the  amount  of  net  earnings  with 
that  of  fixing  upon  a  standard  by  which  to  measure  the 
reasonableness  of  those  earnings. 

There  is  one  other  ground,  besides  that  of  the  intricacy 
and  novelty  of  the  problem,  on  which  the  inclusion  of  earn- 
ings and  of  the  market  value  of  securities  can  be  explained. 
In  a  tax  case  decided  some  years  previously,  both  Justices 
Brewer  and  Harlan  quoted  a  statement  of  the  Indiana  Tax 
Commission,  that  it  had  "considered  the  cost  of  the  con- 
struction and  equipment,  the  market  value  of  the  stocks  and 
bonds,  and  the  gross  and  net  earnings,  and  all  other  matters 
appertaining  thereto  that  would  assist  the  board  in  arriv- 
ing at  a  true  cash  value." 2  To  this  series  of  items  add  the 
amount  (par)  of  the  securities,  and  the  "cost  of  repro- 
duction," both  of  which  were  introduced  into  the  Smyth  v. 
Ames  record,  and  the  "rule"  is  complete.  It  is  quite 
within  the  realm  of  possibilities  that  Justice  Harlan  re- 
ferred to  this  earlier  opinion  in  which  he  had  taken  up  the 
subject  of  "valuation."  At  all  events,  the  similarity  of 
language,  even  to  the  "all  other  matters,"  which  as  "other 

1  Brief  of  J.  L.  Webster,  page  165,  Smyth  v.  Ames,  169  U.S.  466.  See 
also  Brief  of  W.  J.  Bryan,  in  the  same  case,  page  6;  and  Ames  v.  Union 
Pacific,  64  Fed.  165,  177,  178;  and  Smyth  v.  Ames,  169  U.S.  466,  549. 

2  P.C.C.  &  St.L.  Ry.  Co.  v.  Backus,  154  U.S.  421,  433,J  dissenting 
opinion.  Justice  Harlan,  page  437. 


VALUATION  AND  REGULATION  19 

matters"  appeared  in  Smyth  v.  Ames,  is  striking,  and 
probably  not  entirely  without  significance. 

Some  of  the  "elements"  included  in  the  "rule"  have  in 
practice  been  discarded. 

Market  value,  the  value  of  the  railroad  as  registered  in 
stock  and  bond  quotations  —  the  exchange  value,  in  the 
phrase  of  the  economist  —  has  seldom  appeared  in  the  find- 
ings of  fact  upon  which  the  courts  have  based  the  determi- 
nation of  "fair  value."  The  reason  assigned  for  thus  pass- 
ing over  the  figures  with  scant  courtesy  has,  however, 
usually  been  that  of  impracticability.  There  has  been  no 
notice  of  the  theoretical  difficulty,  the  necessary  depend- 
ence of  the  value  of  securities  upon  the  regularity  and 
amount  of  the  income  paid.  Instead  tables  showing  quota- 
tions, usually  averages  over  a  period  of  years,1  have  been 
introduced,  commented  upon  briefly;  and,  be  it  said, 
unfavorably,  then  rejected  with  no  apparent  notice  of  the 
presence  of  the  vicious  circle.  The  stock  and  bond  valua- 
tion has  been  held  "unreliable"  because  including  prop- 
erty not  devoted  to  railroad  purposes,2  or  because  "sub- 
ject to  great  fluctuation  from  causes  wholly  foreign  to 
the  intrinsic  values  of  the  properties."  3  Are  not  stocks 
especially  subject  to  the  "vagaries  of  speculation,"  re- 
flecting the  necessities  of  borrowers  on  collateral  and  not 

1  Record,    Minnesota    Rate  Cases,   230    U.S.  352.     Complainant's 
Exhibit  17  — Gray  (N.P.);  Complainant's  Exhibit  67— Drew  (G.N.); 
Complainant's  Exhibit  7  —  Scott  (M.  &  St.L.). 

The  Masters  in  the  Alabama  Cases  were  directed  to  report  the  "aver- 
age market  value"  of  securities  during  the  years  ending  June  30,  1907, 
1908,  1909.  See  Reports  of  W.  S.  Thorington,  Special  Master,  Central 
of  Georgia  Case,  page  75;  Western  Railway  of  Alabama  Case,  page  48; 
Reports  of  W.  A.  Gunter,  Special  Master;  South  and  North  Alabama 
Case,  page  17;  and  Louisville  and  Nashville  Case,  page  48. 

2  Report  of  Chas.  E.  Otis,  Special  Master,  page  240.  Record  (N.P.), 
Minnesota  Rate  Cases,  230  U.S.  352.  Hereafter  references  to  the  Record 
in  the  Minnesota  Rate  Cases  will  be  cited  simply  as:  Minnesota  Rate 
Cases,  Record  (N.P.);  Record  (G.N.);  Record  (M.  &  St.L.). 

1  Report  of  Chas.  E.  Otis,  page  240. 


20  RAILROAD  VALUATION 

facts  useful  in  an  investigation  aiming  to  establish  "fair 
value  "?  1  The  Master  in  the  Minnesota  Rate  Cases  found 
it  "impossible  to  determine  with  any  degree  of  certainty 
the  particular  elements  which  from  time  to  time  cause  such 
fluctuations."  2 

Whether  he  realized  the  presence  of  a  logical  difficulty  is 
very  doubtful.  For,  after  quoting  Henry  C.  Adams  to  the 
effect  that  a  commercial  valuation  could  not  be  of  service 
in  a  rate  case,  because  of  its  dependence  upon  apparent 
income  (the  earning  of  interest  on  bonds  and  dividends),  he 
said:  "Valuation  of  properties  for  taxation  would  include 
all  the  properties  of  the  corporation  whether  devoted  to 
the  public  service  or  not,  and  in  such  case  the  market  value 
of  stocks  and  bonds  issued  by  it  would  be  an  important 
element  of  value.'*  3  And  with  this  obvious  non  sequitur 
the  whole  difficulty  was  waved  aside.  Justice  Hughes 
merely  commented  that  the  Master  was  "undoubtedly 
right"  in  rejecting  figures  which  included  non-operating 
properties.4 

In  the  Missouri  Rate  Cases,  the  lower  court  had  accepted 
tax  assessments  (multiplied  by  three)  as  a  measure  of  "  fair 
value  " 5  over  the  protest  of  the  attorneys  for  the  State. 
Among  other  things  it  was  alleged  that  the  Tax  Board  was 
required  to  take  into  account "  the  income  of  the  property, 
and  the  income  might  be  unduly  high,  and  upon  that  basis 
give  an  unduly  high  valuation  to  the  property."  6  In  the 
Arkansas  Cases,  where  the  basis  of  taxation  (doubled)  was 

1  Consolidated  Gas  Co.  v .  New  York,  157  Fed.  849,  870. 

The  report  of  the  Special  Master  (Record,  page  211,  Willcox  v.  Con- 
solidated Gas  Co.,  212  U.S.  19)  declared  also  that  it  was  impracticable 
"  to  determine  with  any  degree  of  accuracy  what  proportion  of  its  out- 
standing capitalization  represents  its  assets  invested  in  the  gas  business." 

2  Report,  page  240.  8  Ibid. 

*  Minnesota  Rate  Cases,  230  U.S.  352,  440.  See  also  Judge  Sanbora 
to  the  same  effect,  Shepard  v.  N.P.  Ry.  Co.,  184  Fed.  765,  802. 

6  St.L.  &  S.F.  R.R.  Co.  v.  Hadley,  168  Fed.  317,  323. 

•  Objection  of  F.  W.  Lehmann,  for  the  State,  quoted,  Knotty  C.B.  & 
Q.  R.R.  Co.,  230  U.S.  474,  503. 


VALUATION  AND  REGULATION  21 

also  used,  upon  agreement  of  the  parties,1  District  Judge 
Trieber  had  said :  "  The  value  of  a  railroad  for  taxation,  it 
has  been  uniformly  held  by  the  courts,  may  properly  be 
determined  by  the  value  of  its  bonds  and  stocks."  2  Since 
here  the  parties  to  the  suit,  the  railroads  and  the  State,  had 
made  formal  stipulation  that  the  calculations  should  be 
based  upon  the  assessment  for  taxation,  —  the  reasonable- 
ness of  which  was  "of  course  conceded  by  the  defend- 
ants," 3  —  the  validity  of  such  method  of  determining  "fair 
value  "  was  not  an  issue  before  the  Supreme  Court.4  But  in 
the  Missouri  Cases,  where  no  such  formal  stipulation  had 
been  made,  Justice  Hughes  in  specific  language  rejected 
the  taking  of  tax  valuations  as  "too  general  and  incon- 
clusive to  be  regarded  as  sufficient  proof  to  sustain  the 
values  as  found  .  .  .  when  the  principles  governing  the 
assessments  may  have  rested  upon  methods  which  would 
be  inadmissible  in  ascertaining  the  reasonable  value  of  the 
property  as  a  basis  for  charges  to  the  public."  What  such 
methods  would  have  been,  the  Court  did  not  say.5 

1  The  same  stipulation  was  made  by  the  roads  concerned  in  the  Ala- 
bama Cases:  See  Western  Railway  of  Alabama  v.  R.R.  Commission  of 
Alabama,  197  Fed.  954,  970. 

2  In  re  Arkansas  Rates,  187  Fed.  290,  319,  with  citations. 
*  Ibid.,  page  310. 

''   *  Allen  v.  St.L.I.M.  &  S.  Ry.  Co.,  230  U.S.  553,  556. 

B  Knott  v.  C.B.  &  Q.  R.R.  Co.,  230  U.S.  474,  499-502. 

The  Interstate  Commerce  Commission  has,  however,  expressed  the 
opinion  that  the  market  value  of  the  stocks  and  bonds  may  be  useful 
evidence  in  fixing  "value."  Said  Commissioner  Prouty  in  the  Eastern 
Advance  Case  of  1910,  "  We  are  not  fixing  the  value  of  a  collection  of  ties 
and  rock  and  steel  rails,  but  of  a  railroad  equipped  and  doing  business. 
What  is  that  railroad  worth  as  a  railroad  for  the  transaction  of  a  railroad 
business  ?  .  .  .  Now  the  market  value  of  the  stocks  and  bonds  of  each  of 
these  carriers  represents  the  sum  which  that  property  will  bring  in  the 
open  market.  ...  It  is  the  only  way  in  which  the  value  of  these  proper- 
ties can  be  determined  by  the  test  of  bargain  and  sale."  (20  I.C.C.  243, 
259.)  Too  much  emphasis  should  not  be  placed  upon  what  may  well  have 
been  meant  simply  as  a  passing  comment.  As  Commissioner  Prouty  later 
frankly  stated,  the  discussion  assumed  the  reasonableness  of  existing 
rates.  He  spoke  also  of  this  "  value,"  being  that "  worked  out  in  the  actual 
operations  of  recent  years  in  competition  with  its  rivals,"  as  "  at  least  a 


22  RAILROAD  VALUATION 

Nor  has  emphasis  attached  to  the  par  value  of  the  stocks 
and  bonds.  It  was  thought  "fortunate"  by  the  Railroad 
Securities  Commission  that  the  volume  of  securities  was 
but  one  among  many  matters  to  be  considered  in  a  determi- 
nation of  "value."  The  "dictates  of  precedent"  were  thus 
made  to  "coincide  with  those  of  business  sense."  For  "the 
attempt  to  make  the  face  value  of  securities  issued  the  de- 
termining factor  in  rates  would  result  in  putting  a  pre- 
mium on  roads  which  had  been  speculatively,  not  to  say 
dishonestly,  built  or  managed,  by  allowing  them  to  charge 
higher  rates  on  account  of  the  inflated  capital  thus  pro- 
duced." l  Indeed,  the  Supreme  Court  has  now  expressed 
entire  skepticism  of  the  usefulness  of  the  amount  of  the 
capitalization  as  bearing  upon  the  reasonableness  of  the 
return.2 

The  cost  figures  which  have  been  presented  to  fulfill  the 
demand  of  the  "rule"  have  sought  to  measure  the  proceeds 
of  securities.  The  Master  in  the  Minnesota  Rate  Cases 
merely  took  the  figures  for  the  entire  systems,  as  introduced 
by  the  company  witnesses,  and  assigned  the  proportion  to 

strong  index  of  the  value  of  that  property  in  comparison  with  other  prop- 
erties in  this  [Official  Classification]  territory."  It  would  seem,  however, 
that  Mr.  Prouty  was  thinking  of  the  old  problem  of  recognizing  vested 
interests,  involving  ethical  rather  than  economic  considerations.  Once  the 
plant  is  built,  investment  in  the  securities  of  the  company  continues, 
though  the  creation  of  no  new  "capital  goods"  is  thereby  insured.  Such 
transactions  take  place  entirely  apart  from  the  operations  of  the  railroad 
whose  earnings  simply  accrue  to  new  shareholders,  who  join  the  enter- 
prise after  the  success  of  the  enterprise  is  assured.  The  same  income  reg- 
ularly accruing  (in  dollars)  is  capitalized  at  a  lower  rate  with  partial 
elimination  of  risk.  The  market  value  of  the  securities  is  greater.  And  it 
is  at  these  higher  prices  that  the  purchases  are  made  for  "widows  and 
orphans"  seeking  conservative  investments,  and  for  the  institutions 
for  which  the  "widows  and  orphans"  may  be  said  to  stand.  See  the  tes- 
timony of  President  McCrea,  of  the  Pennsylvania,  quoted,  Evidence, 
1910  Advances,  page  5039. 

1  Report,  Railroad  Securities  Commission  (November,  1911),  page  32. 

2  Smyth  t.  Ames,  169  U.S.  466,  544;  Knoxville  ».  Knoxville  Water 
Co.,  212  U.S.  1,  11. 


VALUATION   AND   REGULATION  23 

Minnesota  which  the  total  mileage  in  that  State  bore  to 
the  system  mileage.  This  figure  was  "considerably  less 
than  the  valuation  of  the  physical  properties  as  found," 
since  it  made  "no  allowance  for  appreciation  of  property 
incident  to  the  growth  or  prosperity  of  the  country  in  which 
the  company  is  entitled  to  share."  He  recognized,  however, 
that  division  on  a  mileage  basis  was  "for  the  most  part 
arbitrary  and  unreliable."1  The  lower  court  turned  to 
the  argument  that  cost  five  to  forty  years  ago  might  be 
"evidence"  of  value  in  1908,  though  it  was  "certainly  no 
criterion."  2  The  attorneys  for  the  State  insisted  that  this 
decision  by  the  Master  and  Court  meant  "ignoring" 
original  cost,  not  "considering"  it.  If  the  original  cost 
be  a  "material  element"  in  "fair  value"  —  they  too 
held  to  the  "rule"  in  Smyth  v.  Ames,  —  "each  of  the  com- 
plainants has  failed  to  sustain  the  burden  resting  upon 
him,  and  the  findings  are  insufficient  to  support  the  ulti- 
mate conclusion."  3 

1  Report  of  Chas.  E.  Otis,  page  241.  There  was  no  mention  of  improve- 
ments from  earnings;  nor  was  the  character  of  the  Minnesota  lines  as 
compared  with  the  mountain  construction  considered.  Even  Justice 
Hughes  did  not  challenge  these  figures.  (230  U.S.  352,  441.)  The  testi- 
mony bearing  on  this  aspect  of  the  case  is  found  in  the  Record  (N.P.), 
page  259  and  following,  page  592  and  following;  Record  (G.N.),  page 
1910  and  following;  Record  (M.  &  St.L.),  page  1. 

8  Shepard  v.  N.P.  Ry.  Co.,  184  Fed.  765,  803.  See  Brief  for  the  Com- 
panies, Minnesota  Rate  Cases,  page  131  and  following. 

»  Brief  for  the  State,  Minnesota  Rate  Cases,  page  126. 

In  the  Spokane  Case,  Commissioner  Prouty  discussed  at  length  the 
"original  cost,"  as  shown  by  the  accounts,  as  well  as  the  cost  of  repro- 
duction estimates.  15  I.C.C.  376,  398  (N.P.);  403  (G.N.). 

In  the  Knoxville  Case,  a  figure  of  "invested  value,"  purporting  to 
indicate  the  cost  of  the  various  units  of  plant,  was  introduced  by  the 
company.  This  estimate,  however,  was  purely  an  exploit  of  the  imagina- 
tion. "The  books  were  not  consulted  at  any  time  for  prices  of  materials" 
(Record,  page  838) ;  the  maker  of  the  estimate  "  carefully  avoided  making 
use  of,  or  referring  to  account  books,"  but  made  his  analysis  upon  "in- 
formation and  experience  as  engineer  and  expert "  (page  635).  The  work  of 
making  this  estimate  (it  purported  to  be  accurate  to  the  final  cent)  was 
done  in  Boston  (page  811).  Knoxville  v.  Knoxville  Water  Co.,  212  U.S.  1. 

See,  however,  the  report  of  the  Public  Service  Commission  of  Massa- 


24  RAILROAD  VALUATION 

By  an  amendment  to  the  Act  to  Regulate  Commerce, 
passed  in  1913,  the  Interstate  Commerce  Commission  is  as- 
signed the  task  of  "valuing"  the  railroads.  A  "physical 
valuation,"  supplemented  by  accounting  investigation7,  is 
provided,  the  purpose  being  to  examine  the  history  and 
organization  of  each  railroad,  without  emphasis  upon  the 
amount  of  the  capitalization.  Otherwise  the  Act  of  Con- 
gress follows  the  language  and  spirit  of  Smyth  v.  Ames  in 
entirely  orthodox  fashion.  The  Commission  is  directed  to 
"ascertain  and  report  in  detail  as  to  each  piece  of  property 
owned  or  used  by  such  common  carrier,  the  original  cost  to 
date,  the  cost  of  reproduction  new,  the  cost  of  reproduc- 
tion less  depreciation,  and  an  analysis  of  the  methods  by 
which  these  several  costs  are  obtained,  and  the  reason  for 
their  differences,  if  any  ";  in  like  manner,  to  "  ascertain  and 
report  separately  other  values,  and  elements  of  value,  if  any, 
of  the  property  of  such  common  carrier,  and  an  analysis  of 
the  methods  of  valuation  employed,  and  of  the  reasons  for 
any  difference  between  such  value  and  each  of  the  forego- 
ing cost  values."  *  In  this  language  the  bill  aims  to  cover 
"going  value,  good- will  value,  and  franchise  value" — 
"intangible  values."  2 

But  the  statute  commits  Congress  to  no  theory  of 
"valuation."  The  entire  burden  of  weighing  "the  ele- 
ments of  value"  is  thrown  upon  the  Commission,  which 
presumably  possesses  the  technical  knowledge  to  cope  with 
the  problem.  Before  a  "tentative  valuation"  can  become 
"final,"  however,  the  Commission  must  notify  the  carrier 
concerned,  the  Attorney  General  of  the  United  States,  the 

chusetts,  "The  Middlesex  and  Boston  Rate  Case,"  where  it  was  held  that 
under  Massachusetts  law  the  honest  and  reasonably  prudent  investment, 
represented  under  normal  conditions  by  the  capitalization,  must  be  taken 
as  the  basis  of  reckoning  fair  and  reasonable  rates.  Second  Annual 
Report,  Public  Service  Commission  of  Massachusetts,  volume  1,  page  99. 

1  Section  19a,  the  Act  to  Regulate  Commerce. 

8  "Valuation  of  the  Several  Classes  of  Property,"  etc.  Senate  Report, 
1290,  62d  Congress,  3d  Session  (hereafter  cited  as  "Senate  Report  on 
Valuation  ")»  page  S. 


VALUATION  AND^  REGULATION  25 

Governor  of  any  State  in  which  the  road's  property  may 
lie,  and  even  "  such  additional  parties  as  the  Commission 
may  prescribe,"  stating  the  amount  of  this  "valuation." 
If  no  protest  is  lodged  within  thirty  days,  the  "said 
valuation"  becomes  "final."  But  where  protest  is  filed,  the 
Commission  must  hold  hearings,  to  consider  any  relevant 
matter  presented  in  support  of  the  protest;  and,  if  of  the 
opinion  that  the  "tentative"  valuation  should  not  be  made 
"final,"  may  "make  such  changes  as  may  be  necessary." 
Altogether  the  task  of  the  Commission  would  not  seem  a 
happy  one.  To  apply  Smyth  v.  Ames  in  a  way  that  shall 
satisfy  the  railroads,  the  Attorney  General  of  the  United 
States,  and  above  all  the  Governors  of  forty-eight  States, 
with  their  local  railroad  commissions,  is  difficult  enough. 
But  what  of  the  courts? 

The  act  is  framed  to  limit  the  judicial  interference  with 
the  independent  determination  of  "fair  value"  by  the 
Commission.  All  "final  valuations"  fixed  under  the  provi- 
sions of  the  statute  ("and  the  classification  thereof,"  i.e., 
cost,  "cost  of  reproduction,"  etc.)  "shall  be  prima  facie 
evidence  of  the  value  of  the  property  in  all  proceedings 
under  the  Act  to  regulate  commerce  .  .  .  and  in  all 
judicial  proceedings  brought  to  enjoin,  set  aside,  annul,  or 
suspend,  in  whole  or  in  part,  any  order  of  the  Interstate 
Commerce  Commission."  Where  evidence  is  introduced 
"different  from  that  offered  upon  the  hearing  before  the 
Commission  or  additional  thereto  and  substantially  affect- 
ing said  value,  the  Court  before  proceeding  to  render 
judgment  shall  transmit  a  copy  of  such  evidence  to  the 
Commission,  and  shall  stay  further  proceedings  in  said 
action  for  such  time  as  the  Court  shall  determine  from  the 
date  of  such  transmission."  But  the  Commission  is  not 
required  to  rescind  or  alter  the  original  figure  of  "final 
value."  It  must  consider  the  new  evidence,  and  it  may 
report  an  "altered,  modified,  or  amended"  order,  upon 
which  "judgment  shall  be  rendered,  as  though  made  by 


26  RAILROAD   VALUATION 

the  Commission  in  the  first  instance."  But  if  the  original 
order  is  not  rescinded  or  changed  by  the  Commission, 
judgment  will  be  rendered  upon  the  original  order.  The 
theories  of  "valuation"  of  the1  Interstate  Commerce 
Commission  are  those  which  shall  govern.1 

The  decisions  of  the  Commission  do  not,  however,  in- 
dicate a  reasoned  theory  of  "  valuation."  The  "  judg- 
ment "  of  the  Supreme  Court  has  been  quoted;  there  has 
even  been  discussion  under  each  of  the  several  heads;  but 
there  has  been  an  expressed  realization  of  the  "  indefinite- 
ness"  of  the  "law  "  Commissioner  Prouty  (the  Eastern 
Advance  Case  of  1910)  had  only  to  repeat  a  complaint  he 
had  voiced  eight  years  previously : 

"It  is  plain  that  until  there  be  fixed,  either  by  legislative 
enactment  or  judicial  interpretation,  some  definite  basis  for 
the  valuation  of  railroad  property  and  some  limit  up  to  which 
that  property  shall  be  allowed  to  earn  upon  that  valuation, 
there  can  be  no  exact  determination  of  these  questions.  In 
the  absence  of  such  a  standard  the  tribunal,  whether  court  or 
commission,  which  is  called  upon  to  consider  this  matter,  can 
only  rely  upon  the  exercise  of  its  best  judgment."  2 

Congress,  however,  when  the  opportunity  to  establish  a 
"definite  basis"  was  before  it,  was  guilty  of  the  same  lack 
of  explicitness  which  has  characterized  the  decisions  of  the 
courts.  The  burden  of  responsibility  has  been  shifted  to 
the  Commission.  That  body,  overworked  before,  must  fix 
"final  valuations"  and  "the  classification  of  the  elements 
that  constitute  the  ascertained  value."  The  evidence  it 
shall  consider  includes  "the  original  cost  to  date,  the  cost 

1  Section  19a,  the  Act  to  Regulate  Commerce. 

*  Eastern  Advance  Case  of  1910,  20  I.C.C.  243,  261.  The  quotation  is 
from  the  Advance  Case  of  1903,  9  I.C.C.  382,  404;  and,  considering  the 
seriousness  with  which  conjectural  "valuation"  figures  were  discussed 
by  the  Interstate  Commerce  Commission  in  the  Spokane  Case,  and  in  the 
Western  Advance  Case  of  1910,  it  cannot  be  said  that  that  body  has 
treated  the  problem  with  scientific  rigor.  See  discussion,  below,  pages 
53-54. 


VALUATION  AND  REGULATION  27 

of  reproduction  new,  the  cost  of  reproduction  less  deprecia- 
tion .  .  .  other  values  and  elements  of  value."  *  It  is 
difficult  to  see  wherein,  if  at  all,  the  Valuation  Act  repre- 
sents an  advance  over  the  "rule"  in  Smyth  v.  Ames. 

1  See  Senate  Report  on  Valuation,  pages  8  and  9,  and  Section  19a,  the 
Act  to  Regulate  Commerce. 


CHAPTER  II 

PHYSICAL   VALUATION 
"COST   OF    REPRODUCTION  "  —  LAND 

Introduction:  The  task  of  the  economist,  28. 
I.  "  Cost  of  reproduction,"  29. 

Definition,  29.  —  State  and  private  appraisals,  30. 
II.  The  "reproduction"  of  land,  32. 

The  land  multiple,  33.  —  State  experience,  34. 
III.  The  'true  value"  of  land,  37. 

The  "expert"  method,  38.  —  The  "sales"  method,  40.  —  The 
"sales  and  assessment"  method,  41. — The  Minnesota  Rate  Cases, 
and  land  valuation,  41.  —  The  railroad  appraisals,  45. 

STUDY  of  "physical  valuation,"  from  the  point  of  view 
of  economics,  cannot  concern  itself  with  the  technical  en- 
gineering problems.  The  measurement  and  count  of  the 
properties  and  the  classification  of  the  various  units  of 
quantity  must  be  left  with  the  engineer.  The  economist  is 
interested  in  the  result  as  set  forth  in  the  total  for  the 
appraisal.  He  can  insist,  in  the  first  place,  that  the  figures 
finally  presented  shall  not  set  claim  to  an  accuracy  that  is 
specious;  and,  in  the  second  place,  that  figures  secured  on 
fallacious  hypotheses  shall  not  be  introduced  as  a  basis  for 
an  attempted  solution  of  an  economic  problem.  But  with 
the  engineering  aspects,  per  se,  he  is  not  concerned. 

The  appraisals  made  have  sought  to  determine,  not  the 
volume  of  the  unimpaired  investment  (of  "unripened" 
savings)  represented  by  the  plant,  but  "  cost  of  reproduc- 
tion," with  deduction  made  to  take  account  of  accrued 
depreciation.  The  consideration  of  the  theoretical  justi- 
fication for  this  basis,  or  the  lack  of  such  justification,  is 
a  matter  of  subsequent  discussion.  In  this,  and  the  suc- 
ceeding chapter,  the  accuracy  of  the  figures  secured  will  be 
considered. 


PHYSICAL   VALUATION  29 


"Cost  of  reproduction"  may  be  defined  as  the  esti- 
mated investment  necessary  to  duplicate  an  existing  rail- 
road, not  to  create  a  substitute  plant  equally  effective.1 
This  definition,  itself  simple,  involves  certain  vigorous  hy- 
potheses. The  road  bed  is  assumed  to  disappear,  and  in 
place  of  the  smoothed  and  well-tended  grade  the  conditions 
met  at  the  time  of  construction  are  restored.  The  right  of 
way  and  terminal  properties  pass  into  private  hands  to  be 
devoted  to  the  same  use  as  adjoining  tracts.  The  equip- 
ment vanishes,  the  working  force  is  scattered.  The  very 
corporate  existence  ceases. 

But  the  process  of  reversion  stops  here.  Any  other  rail- 
road serving  the  same  section,  either  as  a  parallel  and  com- 
peting line,  or  as  a  terminal  connection,  remains  untouched, 
available  to  transport  materials  of  "reconstruction."  And 
these  materials  are  drawn,  not  from  the  sources  originally 
used,  but  from  those  now  available.  The  population,  rural 
and  urban,  does  not  desert  the  line  of  the  road;  busy 
factories  and  warehouses  stand  at  the  edge  of  a  primeval 
right  of  way,  which  is  overgrown  with  trees  and  under- 
brush. Everything  awaits  the  advent  of  the  courageous 
promoter  who  shall  place  surveying  parties  in  the  field, 
secure  a  charter,  arrange  financial  matters:  in  short,  set 
out  to  restore  the  plant  of  the  road  which  in  imagination 
has  been  made  to  disappear,  yet  which  in  fact  exists.  ^  What 
will  it  cost?  And,  having  the  "cost  of  reproduction  new," 
how  much  of  this  "investment"  would  be  existing  at  a 
period  in  the  future  with  the  new  hypothetical  units  as  old 

1  See  James  E.  Allison,  "Ethical  and  Economic  Elements  in  Public 
Service  Valuation,"  Quarterly  Journal  of  Economics,  volume  27,  page 
27;  the  Brief  filed  with  the  Interstate  Commerce  Commission,  on  behalf 
of  the  railroads  represented  in  the  Presidents'  Conference  Committee, 
hereafter  cited,  as  the  "Valuation  Brief  of  1915";  and  statement  of 
Pierce  Butler,  Valuation  Conference  of  September  30,  1915,  Proceedings, 
page  12  and  following. 


30  BAILROAD  VALUATION 

and  in  the  same  physical  condition  as  those  now  in  place? 
The  answer  to  this  question  is  the  engineer's  "present 
value,"  the  "cost  of  reproduction  less  depreciation."  l 

The  Interstate  Commerce  Commission,  which  is  directed 
to  determine  the  "cost  of  reproduction  new,"  and  the 
"cost  of  reproduction  less  depreciation,"  does  not  enter 
upon  an  untouched  field.  Entirely  aside  from  the  apprais- 
als made  by  individual  carriers  to  furnish  evidence  in  rate 
cases, "  as  the  Supreme  Court  in  the  case  of  Smyth  v.  Ames  " 
has  told  them  "  to  do," 2  no  less  than  eight  States  have  made 

1  This  definition  of  the  "cost  of  reproduction"  is  based  upon  the  neces- 
sary assumptions  made  in  order  to  account  for  the  items  included  in  the 
appraisals  made.  See  testimony  of  D.  C.  Morgan,  the  Chief  Engineer  of 
the  Minnesota  Commission,  Minnesota  Rate  Cases,  Record   (N.P.), 
page  1762;  of  W.  L.  Darling,  the  Chief  Engineer  of  the  Northern  Pacific, 
ibid.,  page  5  and  following;  of  A.  H.  Hogeland,  of  the  Great  North- 
ern, Record  (G.N.),  page  2  and  following;  and  of  J.  F.  Stevens,  ibid., 
page  466.    See  also,  Proceedings,  Valuation  Conference  of  May  27-29, 
1915;   the  Valuation  Brief  of  1915;  and  the  Reply  Brief  filed  on  behalf 
of  the  National  Association  of  Railway  Commissioners,  page  18  and 
following. 

2  Quoted  from  Mr.  Jared  How,  of  counsel  for  the  railroads,  Minnesota 
Rate  Cases,  Record  (N.P.),  page  14.  The  railroads  here  introduced  "  cost 
of  reproduction"  estimates  for  the  Minnesota  mileage  and  those  for  the 
entire  Northern  Pacific  which  had  been  presented  in  the  Spokane  Case 
(Spokane  v.  N.P.  Ry.  Co.,  15  I.C.C.  376,  395)  by  W.  L.  Darling,  the 
Chief  Engineer  of  the  Northern  Pacific,  Record  (N.P.),  pages  5-121, 
534-90,  936-1023,  3207-47  ;  and  by  J.  B.  Berry,  then  Chief  Engineer  of 
the  Rock  Island,  ibid.,  pages  718-904 ;  of  the  Great  Northern,  by  A.  H. 
Hogeland,  its  Chief  Engineer,  Record  (G.N.),  pages  2-162;  990-1077; 
1557-1734;  of  the  M.  &  St.L.,  by  A.  S.  Cutler,  Record  (M.  &  St.L.),  pages 
909-52. 

The  Alabama  lines  of  the  Central  of  Georgia,  the  Western  of  Alabama, 
the  South  and  North  Alabama,  and  the  Louisville  &  Nashville  were  "val- 
ued" by  their  engineers  for  the  Alabama  Rate  Cases.  Report  of  W.  S. 
Thorington,  Special  Master,  in  the  Central  of  Georgia  Case,  page  109; 
in  the  Western  of  Alabama  Case,  page  56;  Report  of  W.  A.  Gunter,  Special 
Master,  in  the  South  &  North  Alabama  Case,  page  46;  in  the  Louis- 
ville &  Nashville  Case,  page  83. 

J.  F.  Stevens,  then  Vice-President  of  the  New  Haven,  had  charge  of 
an  appraisal  of  that  road  as  of  the  year  1907.  See  his  testimony,  Minne- 
sota Rate  Cases,  Record  (G.N.),  page  462.  This  "valuation"  was  sub- 
jected to  what  would  appear  to  be  a  perfunctory  check  by  G.  F.  Swain, 
acting  for  the  Massachusetts  "Validation"  Commission.  Report  of 


PHYSICAL  VALUATION  31 

similar  investigations.  The  very  existence  of  these  figures 
automatically  refutes  the  skeptic  who  is  satisfied  that  to 
establish  the  "cost  of  reproduction"  is  an  attempt  to  do 
the  impossible. l  How  reliable  the  results  of  such  apprais- 
als have  been,  and  how  much  worth  while  any  such  figures 
promise  to  be,  are,  however,  entirely  different  questions. 

Massachusetts  Joint  Commission  on  the  N.Y.N.H.  &  H.,  1911.  (The 
New  Haven  Validation  Report.)  W.  J.  Wilgus  made  an  appraisal  of  the 
Lehigh  Valley,  introduced  in  Lehigh  Valley  v.  U.S.,  204  Fed.  986,  988. 

At  the  conferences  between  the  engineers  representing  the  Interstate 
Commerce  Commission  and  the  railroads,  it  developed  that  other  lines 
had  made  "valuations"  of  portions  of  their  plant;  Valuation  Conference 
of  September  4  and  5,  1913,  Proceedings,  page  3  (H.  C.  Phillips,  of  the 
Santa  Fe);  page  9  (E.  Holbrook,  of  the  Southern  Pacific);  page  11  (G.  W. 
Kittredge,  of  the  New  York  Central);  page  21  (J.  B.  Berry,  of  the  Rock 
Island);  page  23  (C.  H.  Smith,  of  the  Missouri  Pacific). 

The  C.B.  &  Q.  was  the  only  road  to  make  formal  attempt  to  intro- 
duce a  "cost  of  reproduction"  estimate  into  the  record  of  the  1910  Ad- 
vance Case  (Evidence,  1910  Advances,  page  978  and  following,  the  testi- 
mony of  F.  E.  Ward,  the  General  Manager).  See,  however,  the  testimony 
of  Wm.  Ellis,  who  "conservatively"  appraised  the  entire  line  of  the 
C.M.  &  St.P.  by  using  the  State  appraisal  figures  for  Wisconsin, 
Minnesota,  and  South  Dakota,  calculating  Illinois  on  the  Wisconsin 
basis;  Iowa  on  the  Minnesota  basis,  etc.,  securing  a  "net  total  of 
$293,318,963.02"  (pages  658  and  5786);  of  E.  P.  Ripley,  who  testified, 
"not  stating  it  merely  as  an  opinion  "  (he  had  "reasons  for  believing  and 
knowing  it "),  that  the  Santa  Fe  "could  not  be  reproduced,  to-day,  for  its 
capitalization"  (page  21);  etc. 

1  The  official  State  appraisals  have  been  made  in  Texas  (see  paper 
by  R.  A.  Thompson,  Chief  Engineer,  Transactions,  Am.  Soc.,  C.E., 
volume  52,  pages  328,  360);  in  Michigan  (Bulletin  21,  Bureau  of  the  Cen- 
sus, Commercial  Valuation  of  Railway  Operating  Property,  page  76,  the 
report  by  M.  E.  Cooley  who  made  the  appraisal);  in  Wisconsin  (ibid., 
page  82,  the  report  of  W.  D.  Taylor,  Chief  Engineer);  in  Minnesota 
(Supplement,  Report,  Minnesota  Railroad  &  Warehouse  Commission, 
1908);  in  South  Dakota  (Twenty-first  Annual  Report,  Board  of  Railroad 
Commissioners) ;  in  Nebraska  (Fourth  Annual  Report,  State  Railway  Com- 
mission) ;  in  New  Jersey  (Report  on  Revaluation  of  Railroads  and  Canals, 
1911);  and  in  Washington  (Second  and  Third  Annual  Reports,  published 
as  a  single  volume  by  the  State  Railroad  Commission).  The  less  impor- 
tant lines  have  been  appraised  in  Oregon  and  California,  while  Kansas 
has  discontinued  work  in  view  of  the  Federal  appraisal,  though  an  ap- 
praisal of  the  lines  of  the  Union  Pacific  had  been  made.  (First  Report, 
Kansas  Public  Utilities  Commission,  1912.)  The  valuations  in  Michigan, 
Wisconsin,  and  New  Jersey  were  for  taxation. 


32  RAILROAD   VALUATION 

II 

Three  general  groups  of  items  may  be  considered  as  they 
would  appear  in  the  inventory:  land,  covering  the  right 
of  way  and  terminals;  the  permanent  way,  structures  and 
equipment;  and  the  "  overhead  "  or  general  expenses.  Logi- 
cally the  appraisal  of  the  railroad  site  may  be  separated 
from  the  appraisal  of  the  plant  made  by  man  —  the  econ- 
omist's "capital  goods."  Its  acquisition  is  an  essential 
first  step;  and  the  considerations  of  principle  presented  are 
necessarily  different  in  character,  since  land  is  not,  like  the 
items  of  plant,  freely  reproducible.  Neither  does  it  "wear 
out."  Moreover,  here  the  measurement  of  quantities  is 
relatively  simple.  It  is  a  problem  in  two  dimensions,  where 
the  degree  of  error  due  to  inaccurate  surveying  promises  to 
be  negligible.  And,  in  addition,  the  holdings  of  land  are, 
it  may  be  assumed,  largely  a  matter  of  record,  in  the 
offices  of  the  railroads,  or  in  the  public  files.  The  number 
of  acres  and  square  feet  of  land  occupied  by  the  railroad 
may,  therefore,  be  considered  as  determined  within  a 
relatively  narrow  range  of  error. 

But  though  land  cannot  be  "reproduced,"  it  can  be  re- 
acquired.  Keep  clearly  in  mind  the  details  of  the  hypoth- 
esis which  bear  upon  this  aspect  of  the  problem.  Title 
has  passed  from  the  railroad  company  to  private  owners, 
who  are  supposed  to  devote  the  land  to  the  same  purpose 
as  that  for  which  the  adjacent  land  is  used.  This  holds 
true,  even  though,  for  the  purpose  of  "reproducing"  the 
"clearing  and  grubbing,",  it  be  necessary  to  assume  the 
presence  of  the  forest  long  since  cleared  away.  In  the 
country  the  land  is  used  for  farming  (where  available  for 
tillage  or  pasture) ;  and  in  the  cities  there  is  insistence  that 
the  sites  be  devoted  to  trading,  warehouse,  factory  —  even 
residence  purposes. l  Thus  the  land  needed  by  the  railroad 

1  The  following  statement  of  Mr.  Jared  How,  of  counsel  for  the  rail- 
roads in  the  Minnesota  Rate  Cases,  is  typical:  "What  we  are  trying  to 


PHYSICAL   VALUATION  33 

does  not  stretch  in  a  long  vacant  tract  through  country  and 
city.  By  the  same  token  that  the  existing  line  is  conjured 
out  of  sight,  buildings  are  conjured  into  its  place.  Mak- 
ing these  assumptions,  which,  to  the  lay  mind,  may  seem 
strenuous,  the  investigator  has  courageously  set  about  to 
estimate  what  it  would  cost  the  railroad  to  reacquire  the 
land  it  already  possesses.1 

The  presence  of  imaginary  buildings  has  only  in  part 
been  the  justification  of  the  use  of  a  multiple  of  the  "true 
market  value "  of  the  land  in  order  to  determine  its  "cost  of 
reproduction."  The  multiple  has  been  justified  also  on  the 
ground  that  it  is  a  matter  of  "common  knowledge'*  that 
the  railroad  buying  land  in  a  narrow  strip  pays  more  for  it 
than  the  "true  value,"  the  "market  value"  for  farming, 

establish  is  the  value  of  the  Northern  Pacific  Railway  System  as  the 
base  upon  which  we  are  entitled  to  a  fair  return,  if  we  are  entitled  to 
anything.  The  Supreme  Court,  in  the  case  of  Smyth  v.  Ames,  the  utter- 
ance being  by  Mr.  Justice  Harlan,  says  that  one  of  the  elements  to  be 
considered  is  the  present  cost  of  construction  of  the  property  as  it  exists 
in  operation  for  the  public  use.  Some  other  courts  have  said  that  that 
was  the  sole  element  to  be  considered.  Now,  the  present  cost  of  construc- 
tion of  the  Northern  Pacific  Railway  may  be  established  only,  of  course, 
by  considering  that  the  railway  property  does  not  now  exist.  In  estab- 
lishing the  present  cost  of  construction  of  the  railway,  the  first  element, 
manifestly,  is  the  cost  of  acquisition  of  the  railway  right  of  way;  if  no 
railway  property  now  exists,  manifestly  the  right  of  way  must  be  first 
acquired,  and  the  only  method  of  computing  the  present  cost  of  construc- 
tion is  to  start  upon  the  proposition  that  the  property  does  not  exist,  be- 
cause, if  it  does,  you  can't  presently  construct  it.  Now,  that  being  the 
fact,  we  must,  of  course,  establish  the  present  cost  of  acquisition  of  the 
railway  property,  not  upon  the  hypothesis  that  the  Indians  infest  St.  Paul, 
but  on  the  hypothesis  of  the  present  conditions  of  St.  Paul  and  all  other 
points  of  contact."  Record  (N.P.),  page  1067. 

1  The  testimony  of  Thomas  Cooper,  of  the  Northern  Pacific,  — Minne- 
sota Rate  Cases,  Record  (N.P.),  pages  196-97,  — -  illustrates  well  the  signif- 
icance of  this  thesis.  Probably  the  most  extreme  instance  of  conjuring  up 
buildings,  however,  came  before  the  New  York  Public  Service  Commis- 
sion, 1st  District,  in  Re  Metropolitan  Street  Ry.  Reorganization,  3  P.S.C. 
1st  D.  N.Y.  113,  where  it  was  assumed  that  modern  buildings  would  be 
torn  down  to  make  way  for  a  one-story  car  barn  covering  the  city  block 
bounded  by  Fourth  and  Lexington  Avenues,  and  32d  and  33d  Streets 
(pages  139-40). 


84  RAILROAD  VALUATION 

business,  or  residence  purposes,  since  an  element  of  dam- 
age attaches  to  the  division  of  a  tract  into  two  portions, 
etc.1  A  higher  price  paid  by  the  railroad  would  seem, 
moreover,  an  invariable  concomitant  of  the  use  of  the  jury 
in  condemnation  cases.  Whether  the  damage  be  real  or 
imaginary,  the  result  is  certainly  the  same.  The  company 
acquiring  land  does  usually  pay  more  than  its  value  in  the 
service  in  which  the  land  was  formerly  used.  Indeed,  the 
railroads,  having  this  knowledge  born  of  long  experience, 
resort  to  condemnation  only  when  forced  to  do  so.  It  is 
more  economical  to  make  purchases  at  agreed  terms.2 

Multiples,  then,  were  used  in  both  the  Michigan  and 
Wisconsin  appraisals,  the  first  of  the  series  of  "valua- 
tions" made  since  1900.  And  the  precedent  there  estab- 
lished has  persisted  in  the  subsequent  appraisals  whether 
made  by  State  or  corporation  employees.  In  no  case, 
however,  has  there  been  attempt  to  attach  the  railroad  land 
to  specific  adjoining  tracts,  and  to  measure  the  business 
shrewdness  of  the  individual  landowner  by  estimating  how 
much  or  how  little  he  would  demand;  or  to  gauge  that  of 

1  "The  proper  construction  of  the  road  often  makes  access  from  the 
land  on  one  side  to  the  land  on  the  other  more  difficult.  .  .  .  The  natural 
drainage  is  interfered  with.  Roads  and  streets  may  be  closed  or  changed. 
The  noise,  smoke,  danger,  and  inconvenience  from  the  operation  of  rail- 
roads. .  .  .  These  considerations  always  make  the  right  of  way  value  more, 
oftentimes  much  more,  than  its  market  value  for  other  purposes."  In- 
structions to  right  of  way  appraisers,  Wisconsin  Appraisal;  Report,  Wis- 
consin Tax  Commission,  1907,  page  274. 

See  C.  &  N.W.  Ry.  Co.  v.  Smith,  210  Fed.  632,  638,  quoting  testi- 
mony of  C.  C.  Witt,  Chief  Engineer  of  the  South  Dakota  valuation. 

*  Thomas  Cooper,  Minnesota  Rate  Cases,  Record  (N.P.),  pages  136-38; 
244-46;  Charles  Hayden,  Record  (G.N.),  pages  208-17.  Mr.  Cooper 
testified  (pages  136-37) :  "  We  don't  waste  time  looking  for  bargains.  .  .  . 
I  have  gone  as  high  as  twice  what  I  was  satisfied  in  my  own  mind  was  a 
good  liberal  price,  and  if  the  party  will  not  accept  the  increased  price, 
we  reluctantly  resort  to  condemnation."  See  discussion  by  D.  C.  Mor- 
gan, the  Minnesota  State  Engineer,  in  his  report,  page  17,  Supplement, 
Report,  Minnesota  Railroad  &  Warehouse  Commission,  1908;  the  Valua- 
tion Brief  of  1915,  pages  320-23;  and  Argument  of  Thomas  W.  Hulme,  at 
the  Valuation  Conference  of  May  27-29, 1915,  Proceedings,  page  120  and 
following:  containing  a  series  of  interesting  instances. 


PHYSICAL  VALUATION  35 

the  railway  right  of  way  agent.  Nor  has  there  been  neces- 
sity to  reproduce  the  appraising  process  of  an  endless  series 
of  juries.  Prophecy  has  not  been  attempted  where  the 
personal  element  would  vary  so  widely.1  Instead  the 
practice  has  been  to  take  "average"  figures,  to  use  multi- 
ples of  the  "value  of  the  land  for  other  purposes,"  the  size 
of  the  multiple  being  based  upon  investigation  of  the 
ratio  of  the  amount  paid  by  railroads  in  a  given  district  as 
compared  with  what  D.  C.  Morgan,  the  Chief  Engineer  of 
the  Minnesota  Commission,  called  "the  true  value"  of  the 
land.  Since  an  "average"  figure  which  could  be  applied 
generally  has  been  sought,  the  necessity  to  consider  the 
probable  multiple  in  each  acquisition  has  been  eliminated. 
Some  variation  has,  however,  appeared.  In  Texas,  25  to 
50  per  cent  was  added;  in  Wisconsin,  10  to  150  per  cent;  2 
in  Washington,  0  to  500  per  cent  (surely  a  vague  "finding 
of  fact");3  in  Nebraska,  the  Chief  Engineer  added  "a 
minimum  of  50  per  cent,  and  a  maximum  of  225  per  cent," 
for  rural  right  of  way,  and  "  a  minimum  of  25  per  cent  and 
a  maximum  of  100  per  cent"  for  "town  property."  4  In 

1  Mr.  Cooper  —  Minnesota  Rate  Cases,  Record  (N.P.),  page  137  — 
declared  that  when  he  ran  across  a  man  unpopular  with  his  neighbors, 
the  road  "got  off"  with  less.  However,  in  condemnations  "you  run  across 
reasons  that  increase  the  award  against  you  that  you  never  dreamed  of. 
You  will  find  sentimental  reasons  — an  old  home  or  associations,  births, 
deaths,  and  marriages.    The  woman  will  get  on  the  stand  and  she  will 
tell  her  story  and  weep  over  it,  and  every  tear  costs  us  money;  therefore 
condemnations  I  dread.  ..." 

2  Mr.  R.  A.  Thompson  (Texas),  discussing  the  Wisconsin  figures,  de- 
clared that  the  multiple  used  in  Wisconsin  for  country  lands  (250  per 
cent  —  an  addition  of  150  per  cent)  appeared  "  quite  fair,"  but  in  cities 
.  .  .  "too  high,"  especially  for  the  Southwest.  Transactions,  Am.  Soc., 
C.  E.,  volume  72,  page  205.    See  discussion  by  Mr.  Taylor,  of  Wiscon- 
sin, on  a  paper  by  Mr.  Thompson,  on  "  Valuation  of  Railroad  Prop- 
erty," Transactions,  Am.  Soc.,  C.  E.,  volume  52,  page  353. 

*  Second  and  Third  Annual  Reports,  Railroad  Commission  of  Wash- 
ington, page  157  (N.P.);  "findings  of  fact"  covering  each  parcel  of  real 
estate  are  given  in  terms  of  dollars,  so  that  the  exact  multiple  used  does 
not  appear  for  each  item. 

*  Senate  Report  on  Valuation,  page  176. 


36  RAILROAD   VALUATION 

South  Dakota,  where  the  multiple  was  found  "to  range 
from  2  to  5,  the  average  being  about  3  outside  of  towns,"  a 
multiple  of  2j  was  used  for  all  lands,  town  or  country. 
A  similar  general  average  was  used  in  Minnesota,  though 
in  the  three  "terminal  cities,"  lower  multiples  were  applied 
than  in  the  country.1  The  railroad  appraisals,  presented  in 
the  Minnesota  Rate  Cases,  used  the  multiple  of  3  for 
country  right  of  way;  but  this  the  Master  cut  to  2j.  In  the 
cities  he  allowed  an  addition  of  5  per  cent,  over  the  insist- 
ence of  the  railroads  that  5  per  cent  was  only  a  minimum, 
that  the  actual  extra  cost  was  5  to  40  per  cent.2  In  the 
Western  Advance  Case  of  1910  the  General  Manager  of 
the  Burlington  testified  that  his  estimate  of  the  "cost  of 
reproducing"  the  land  included  a  multiple  of  3  over  the 
whole  line,  except  in  principal  cities.3 

Thus,  entirely  aside  from  the  method  of  securing  the 
" market  value"  or  "true  value,"  to  which  the  multiple  or 
percentage  has  been  applied,  considerable  variation  in 
practice  has  appeared.  There  has  been  unanimity  only  in 
the  insistence  that  the  multiple  be  used.  How  large  it 
should  be,  to  which  classes  of  land  it  should  be  applied  — 
these  are  factors  which,  it  must  be  clear,  have  depended 
entirely  upon  the  judgment  of  the  individual  appraiser. 
The  use  of  a  general  average,  or  of  a  series  of  such  averages, 
moreover,  has  constituted  resort  to  approximation,  an 
expedient  which  will  often  appear  in  the  subsequent  dis- 
cussion. 

Justice  Hughes  in  the  Minnesota  Rate  Cases  con- 
demned the  use  of  multiples,  in  part  upon  the  technical 
ground  that  it  was  impossible  to  assume,  "in  making  a 

1  Supplement,  Report,  Minnesota  Railroad  &  Warehouse  Commission, 
1908,  page  15;  in  St.  Paul,  the  multiple  was  If;  in  Minneapolis,  If; 
in  Duluth,  1^;  ibid.,  page  17.  The  country  "multiple"  was  3. 

2  Report  of  Chas.  E.  Otis,  Special  Master,  Minnesota  Rate  Cases, 
pages  220-24. 

1  Evidence,  1910  Advances;  testimony  of  Mr.  F.  E.  Ward,  of  the 
C.B.  &  Q.,  pages  998-1011. 


PHYSICAL  VALUATION  37 

judicial  finding  of  what  it  would  cost  to  acquire  the  prop- 
erty, that  the  company  would  be  compelled  to  pay  more 
than  its  market  value";  in  part  upon  the  ground  that  such 
a  multiplier  covered  a  " hypothetical  outlay."  Accordingly 
Justice  Hughes  pronounced  the  opinion  of  the  Court  that 
"the  allowances  made  below  for  a  conjectural  cost  of 
acquisition  and  consequential  damages  must  be  disap- 
proved."1 This  action,  of  course,  meant  a  wrench  to  the 
"cost  of  reproduction"  theory,  in  fact  a  significant  depar- 
ture from  the  regulation-condemnation  analogy.  It  was 
intended  as  such:  "The  conditions  of  ownership  of  the 
property  and  the  amounts  which  would  have  to  be  paid  in 
acquiring  the  right  of  way,  supposing  the  railroad  to  be 
removed,  are  wholly  beyond  reach  of  any  process  of 
rational  determination.  The  cost  of  reproduction  method 
is  of  service  in  ascertaining  the  present  value  of  the  plant 
when  it  is  reasonably  applied  and  when  the  cost  of  repro- 
ducing the  property  may  be  ascertained  with  a  proper  de- 
gree of  certainty.  But  it  does  not  justify  the  acceptance 
of  results  which  depend  upon  mere  conjecture."  2 


III 

Turn  now  to  the  problem  of  determining  the  "true 
value  "  of  the  railroad  lands.  Resort  has  been  made  to  court 
practice  in  condemnation  cases :  to  reliance  upon  the  prices 
paid  for  adjoining  tracts,  or  upon  the  opinion  of  experts. 
Sometimes,  indeed,  a  "sales  and  assessment"  formula  has 
been  evolved,  reference  being  made  to  taxation  records. 
But  every  one  of  these  expedients  has  proposed  that  the 
measure  of  the  cost  of  reacquiring  the  railroad  land  be  the 

1  Minnesota  Rate  Cases,  230  U.S.  352,  455. 

2  Ibid.,  page  452.  What  would  seem  to  be  positive  language  has,  how- 
ever, not  been  accepted  as  final  by  the  attorneys  representing  the  rail- 
roads  in   the  Federal  valuation.     They  have  insisted  that  "cost  of 
reproduction"  which  the  Commission  is  directed  to  determine  can  be 
estimated  in  no  other  way.  Valuation  Brief  of  1915,  pages  315-70. 


88  RAILROAD  VALUATION, 

value  of  adjacent  tracts.  The  logical  complication  due  to 
the  relation  of  the  presence  of  the  railroad  —  its  effect  upon 
economic  rent,  and  therefore  upon  the  value  of  the  ad- 
jacent tracts  —  has  been  ignored. 

In  Michigan  special  inspectors,  "experts  in  land  values," 
submitted  reports  "so  complete  as  to  leave  no  doubt  of 
the  thoroughness  of  their  investigation."  This  investiga- 
tion depended  upon  the  information  submitted  by  "a 
large  number  of  citizens  who  very  courteously  entered 
upon  the  task  of  filling  out  the  blanks  requesting  informa- 
tion as  to  the  value  of  properties  in  their  respective  lo- 
calities"; supplemented  by  "as  much  personal  inspection 
as  it  was  possible  for  a  few  men  to  give  in  a  limited  time." 
The  result  was  a  series  of  average  "values"  for  various 
classes  of  land  —  farm  land,  barren  land,  land  in  villages  of 
less  than  500,  etc.  It  then  became  necessary  to  classify 
the  amounts  of  each  kind  belonging  to  the  several  roads. 
"In  this  much  assistance  was  received  from  the  local  en- 
gineers (i.e.,  locomotive  engineers),  who,  on  account  of 
their  familiarity  with  their  runs,  were  able  to  give,  with 
considerable  accuracy,  the  extent  of  the  lands  of  different 
grades  on  their  respective  lines."  *  Prices  established,  the 
acreage  of  each  classification  determined  upon  in  this  hit- 
or-miss  method,  it  was  a  simple  task  to  figure  a  cost  of 
reacquiring  land,  set  down  as  if  correct  to  the  last  dollar. 
To  the  totals  here  secured  were  added  expert  appraisals, 
based  upon  investigation  of  sales  records,  of  lands  in  the 
principal  cities.2 

1  M.  E.  Cooley,  Michigan  Railroad  Appraisal,  Bulletin  21,  Bureau  of 
the  Census,  Commercial  Valuation  of  Railway  Operating  Property,  page  77. 

2  See  H.  E.  Riggs,  "  Valuation  of  Public  Service  Corporation  Property," 
Transactions,  Am.  Soc.,  C.E.,  volume  72,  page  52. 

In  the  Alabama  Rate  Cases,  too,  the  largest  dependence  was  placed 
upon  the  appraisals  of  "experts."  Says  Mr.  Thorington,  the  Special 
Master  in  the  Central  of  Georgia  Case:  "  The  right  of  way  agents  went 
over  each  mile  of  all  the  Alabama  lines  of  the  road,  and  from  personal  in- 
spection of  the  right  of  way  and  adjoining  property  .  .  .  and  full  confer- 
ence with  the  owners  of  property  adjacent  to  the  road  and  with  business 


PHYSICAL   VALUATION  39 

The  Washington  Commission  also  employed  experts, 
"following  the  same  general  lines  that  would  be  pursued  in 
court  in  an  ordinary  condemnation  action."  Men  experi- 
enced in  buying  land  for  railroads  made  a  personal  in- 
spection of  "every  line  of  road  within  the  State,  and  every 
piece  of  property  owned  by  the  roads."  In  the  larger  cities 
the  Commission  hired  "expert  real  estate  men  of  high 
standing"  who  investigated  all  the  holdings  of  the  rail- 
roads in  the  cities,  and  subsequently  testified  before  that 
body.  The  railroads  introduced  equally  reliable  (or  un- 
reliable) expert  testimony:  the  Commission  made  "find- 
ings of  fact"  —  probably  no  better  nor  worse  than  the 
Michigan  figures,  but  certainly  hardly  more  conclusive  or 
serviceable.  Unless,  of  course,  it  be  assumed  that  the 
Washington  Commission  made  its  "findings  of  fact"  with 
infallible  insight,  and  that  it  hired  a  peculiarly  infallible 
brand  of  real  estate  expert.1 

men  in  towns  and  with  real  estate  agents,  and  in  some  instances  after  ex- 
amination of  the  records  of  conveyances  for  the  county,  fixed  the  value 
of  the  right  of  way  property,  the  ultimate  valuation  in  every  instance 
being  fixed  after  acquiring  information  as  above  stated,  and  also  based  on 
their  experience."  Report,  page  117.  See  also  his  Report  in  the  Western 
of  Alabama  Case,  pages  62-63. 

1  Second  and  Third  Annual  Reports,  Railroad  Commission  of  Wash- 
ington, page  49. 

The  following  figures  introduced  by  fourteen  "experts,"  testifying  to 
the  value  of  the  same  piece  of  land,  in  a  suit  by  a  railroad  company  to 
condemn  right  of  way  in  Minnesota  indicate  some  of  the  extreme  possi- 
bilities of  expert  testimony: 


For  Owners 

For  Railway 

$76,808 

$1,990 

111,930 

2,583 

121,410 

2,910 

133,719 

3,074 

156,400 

3,825 

230,646 

6,107 

288,345 

8,840 

Cited,  Proceedings,  National  Association  of  Railway  Commissioners, 
volume  21,  page  328. 

In  the  New  York  Gas  Case  the  real  estate  experts'  estimates  ranged 
from  $19,663,507  (the  State  expert)  to  $15,499,500  (the  Company  expert). 


40  RAILROAD  VALUATION 

In  order  to  avoid  this  dependence  upon  expert  testimony 
and  "opinion,"  the  "sales"  method  of  appraising  land 
has  been  used.  When,  in  1902,  Michigan  desired  a  check 
on  the  computations  made  two  years  before,  employees 
were  sent  to  the  offices  of  the  Registers  of  Deeds  "  in  ten  or 
twelve  counties.  ...  A  careful  abstract  of  all  railway  trans- 
fers for  a  period  of  ten  years  was  taken  off,  the  acreage 
determined,  the  average  price  for  different  classes  of  land 
computed,  and  then  a  careful  study  of  transfers  of  adjacent 
improved  and  unimproved  lands  was  made."  l  The  results 
of  this  investigation  were  presumed  to  be  better  than  those 
secured  two  years  earlier.  It  is  difficult  to  see  how  a  ten- 
year  average  covering  various  classes  of  lands  was  neces- 
sarily more  conclusive  than  the  "average"  value  computed 
from  the  opinions  of  bankers  as  applied  to  a  classification 
made  by  locomotive  engineers.  In  the  Wisconsin  appraisal, 
Mr.  Taylor  placed  dependence  upon  similar  investigation 
of  records  of  transfer,  made  under  the  direction,  not  of  an 
economist  or  statistician,  but  of  a  professor  of  mathe- 
matics in  the  state  university.2  This  method,  with  the 
subsequent  addition  of  the  assessment  check,  has  since 
been  generally  used  by  the  Wisconsin  Commission. 

The  theory  behind  the  use  of  the  sales  method  is  very 
well  expressed  in  a  report  of  the  former  Engineer  of  that 
body,  Mr.  W.  D.  Pence,  later  upon  the  staff  of  the  Inter- 
state Commerce  Commission: 

"The  sales  method  may  be  defined  as  a  plan  or  process 
for  the  systematic  collection  and  comparison  of  data  relat- 
ing to  real  estate  transfers  for  the  purpose  of  estimating  true 

There  were  two  figures  of  approximately  twelve  millions,  and  one  of  over 
fourteen.  Report  of  Special  Master,  A.  H.  Masten,  page  157.  Willcox 
c.  Consolidated  Gas  Co.,  212  U.S.  19. 

1  H.  E.  Riggs,  from  whom  this  is  quoted,  was  one  of  the  investigators. 
"Valuation  of   Public    Service  Corporation  Property,"  Transactions, 
Am.  Soc.,  C.E.,  volume  72,  page  54. 

2  W.  D.  Taylor,  Wisconsin  Railroad  Valuation,  Bulletin  21,  Bureau 
of  the  Census,  Commercial  Valuation  of  Railicay  Operating  Property, 
page  85. 


PHYSICAL  VALUATION  41 

market  realty  values.  It  consists  in  a  study  of  the  transfers 
of  neighboring  property  having  conditions  or  characteristics 
similar  to  the  land  whose  value  is  to  be  determined,  and  is 
intended  to  duplicate,  as  nearly  as  may  be,  the  mental  or 
judicial  processes  ordinarily  employed  by  the  so-called  'local 
real  estate  expert,'  with  a  view  to  arriving  at  results  approxi- 
mating those  which  would  be  reached  by  such  local  expert 
acting  without  bias  or  suggestion." 

The  sales  and  assessment  method,  on  the  other  hand,  is 
designed  to  introduce,  "as  far  as  may  be,  the  judicial 
processes  of  the  assessor  who,  at  least  in  theory,  serves  on 
behalf  of  the  public  as  an  unbiased  expert."  The  sales 
method  attempts  to  duplicate  "the  mental  process"  of 
the  expert;  the  sales  and  assessment  method,  the  "judicial 
process  of  the  assessor"  —  in  neither  case  a  promising  rec- 
ommendation.1 

The  Minnesota  Rate  Cases  presented  the  problem  of 
appraising  lands  as  a  significant  issue.  Here  the  com- 
panies based  their  claims  upon  expert  testimony,  and  the 
State  upon  the  sales  method,  except  in  the  three  cities  of 
Duluth,  St.  Paul,  and  Minneapolis,  where  the  sales  and 
assessment  method  was  used.  In  the  record  of  this  case, 
therefore,  the  relative  advantages  and  disadvantages  of  the 
different  methods  can  be  sought  out.  In  no  instance  does 
it  seem  that  a  degree  of  accuracy  was  promised  which  would 
warrant  acceptance  of  the  results  in  a  scientific  analysis, 
quite  apart  from  any  challenge  of  the  premises,  themselves. 

The  "valuation"  of  1907  made  for  the  Minnesota  Rail- 
road and  Warehouse  Commission  was  for  the  ostensible 
purpose  of  using  the  figures  secured  as  the  basis  of  measur- 
ing the  reasonableness  of  the  return  to  the  railroads  from 
intrastate  business.2  In  all  essential  aspects,  however,  the 

1  State  Journal  Printing  Co.  v.  Madison  G.  &  E.  Co.,  4  W.R.C.R.  501, 
528-33;  also  Hill  r.  Antigo  Water  Co.,  3  W.R.C.R.  623,  670;  and  Buf- 
falo Gas  Co  v.  City  of  Buffalo,  3  P.S.C.  2d  D.  N.Y.  553,  643. 

a  D.  C.  Morgan,  Minnesota  Rate  Cases,  Record  (N.P.),  page  1972. 


42  RAILROAD  VALUATION 

appraisal  was  upon  the  same  basis  as  the  Michigan  and 
Wisconsin  appraisals,  which  had  been  made  for  taxation 
purposes.  The  "valuation"  of  the  lands  outside  the  cities 
is  hardly  significant  for  the  present  discussion.1  Chief 
Engineer  Morgan's  letter  of  instruction  to  the  special  land 
agents  directed  an  examination  of  the  record  of  transfers 
of  real  estate  subsequent  to  January  1,  1900  (though  the 
appraisal  was  as  of  June  30,  1907),  "obtaining  therefrom 
all  transfers  within  one  and  one  half  miles  on  each  side  of 
the  center  line  .  .  .  and  in  such  instances  as  the  records  do 
not  show  sufficient  activity  in  the  sale  of  property  to  enable 
intelligent  and  fairly  complete  data,"  extending  the  inquiry 
to  sales  beyond  the  one  and  one  hah*  mile  line.  Besides  this 
examination  of  the  records,  "inquiry  among  real  estate 
men,  bankers  and  business  men"  was  directed  "to  en- 
able confirmation  of  the  data  obtained  from  the  county 
records." 2  These  instructions  reflect  two  weaknesses. 
Prices  of  1900  signified  nothing  regarding  real  estate  values 
of  1907;  the  value  of  land  a  mile  and  a  hah*  away  was  not 
a  conclusive  index  of  the  value  of  the  land  immediately 
adjacent  to  the  railroad.  Though,  of  course,  with  a  multi- 
ple of  three  to  be  applied  —  chosen  as  an  approximation  — 
it  was  hardly  necessary  to  bother  with  minor  difficulties.  It 
should  be  enough  that  more  than  55,000  sales,  representing 
more  than  1,300,000  acres,  and  "involving  considerations 
approximating $100,000,000,"  were  "taken  into  considera- 
tion." 3  Regardless  of  the  validity  of  the  premises,  surely 
this  represented  painstaking  research. 

1  In  some  of  the  smaller  towns,  Mr.  Morgan  used  his  own  "judgment" 
(ibid.,  page  2083);  or  compared  the  "values"  given,  with  "values"  of 
other  towns  of  similar  size  (page  2129).  It  seems  that  in  general  he 
merely  decreased  the  company  estimates  by  20  per  cent,  50  per  cent,  etc. 
See  testimony  of  Thomas  Cooper  (pages  3055-57).  Mr.  Cooper  had  some 
independent  appraisals  made  by  local  "experts"  in  those  towns  (page 
3060  and  following). 

1  Supplement,  Report,  Railroad  &  Warehouse  Commission  of  Minne- 
sota, 1908,  page  12. 
•   *  Ibid.,  page  13. 


PHYSICAL  VALUATION  43 

In  making  his  appraisal  of  the  terminal  properties  in  the 
Twin  Cities  and  Duluth,  Mr.  Morgan  found  his  work  in 
applying  the  sales  and  assessment  method  much  simplified 
by  certain  investigations  made  by  the  State  Tax  Commis- 
sion, and  in  St.  Paul,  by  the  Tax  Committee  of  the  City 
Council.  These  investigations  aimed  to  determine  the 
ratio  of  the  selling  price  of  land  and  the  assessed  valuation. 
The  figure  which  Mr.  Morgan  actually  used,  however,  while 
found  in  the  report  of  the  City  Council  Committee,  first 
appeared  in  a  newspaper  article  late  in  1906.  During  the 
year  1905,  2654  transfers  of  St.  Paul  real  estate  had  been 
made  by  deed;  these  were  listed  by  assessment  districts, 
the  consideration  in  one  column,  the  assessed  valuation  in 
another.  For  each  district  the  ratio  of  assessment  to  the 
consideration  was  then  calculated.  This  ranged  from 
50.25  per  cent  to  65.72  per  cent.  For  the  total  2654  trans- 
fers the  ratio  was  approximately  60  per  cent.  This  figure 
of  60  per  cent,  therefore,  Mr.  Morgan  chose  as  a  reliable 
index  of  the  ratio  of  assessed  value  to  "true  value"  —  and 
made  it  the  basis  of  estimating  the  cost  of  reproducing  the 
terminal  properties  in  St.  Paul.1  In  Minneapolis  the  figure 
was  54.7  per  cent.2 

Even  had  he  possessed  assessments  of  railroad  property 
made  through  the  same  judicial  process  on  which  the  assess- 
ment ratio  was  based,  Mr.  Morgan  would  have  been  pre- 
suming in  attempting  to  apply  any  such  general  average 
to  that  assessed  valuation,  in  order  to  determine  the  "true 
value  "  of  the  land.  The  figure  itself  meant  nothing;  it  was 
simply  a  general  average  which  served  to  bulk  a  large 
number  of  varying  ratios.  In  fact,  as  Mr.  Morgan  himself 
testified,  the  report  of  the  Council  Committee  in  St.  Paul, 
presenting  a  table  of  actual  transactions,  showed  a  range 
of  percentages  from  33  to  over  130.3  So,  while  he  did  not 

1  D.  C.  Morgan,  Minnesota  Rate  Cases,  Record  (N.P.),  pages  1982, 
1998,  and  following. 
-   a  Ibid.,  page  1818.  '  Ibid.,  page  1983. 


44  RAILROAD   VALUATION 

claim  that  the  ratio  of  60  per  cent,  applied  to  a  single  tract 
would  indicate  a  "true  result,"  l  nevertheless  he  "didn't  un- 
dertake to  take  into  account  the  individual  inequalities.*' 2 
When  investigations  were  confined  to  a  small  area,  "there 
might  perhaps  be  only  one  or  two  sales  in  that  locality,  and 
they  might  not  represent  anything  like  the  correct  condi- 
tion." The  figure  of  60  per  cent  therefore  was  chosen  on  the 
theory  that  it  "would  compensate  one  way  and  another" 
and  that  the  appraisal  would  thus  reach  "fairly  equal 
ground."  3 

In  Minnesota,  however,  the  railroads  paid  a  gross  earn- 
ings tax,  and  no  "reliable"  assessments  of  the  railroad 
lands  were  at  hand  to  which  to  apply  the  convenient  ratio. 
For  this  reason  it  was  "necessary"  to  measure  the  "cost 
of  reproduction"  from  the  "average  value  of  contiguous 
and  surrounding  property."  Accordingly,  therefore,  Mr. 
Morgan  divided  the  terminal  lands  of  each  railroad  into 
sections  —  the  length  of  each  section  varying  in  accord- 
ance with  his  "best  judgment."  An  "arbitrary"  4  area  on 
either  side  of  the  center  line  in  each  of  these  sections  was 
marked  out,  and  investigation  was  made  to  determine  the 
"market  value"  of  land  within  each  area.5  The  first  step 
was  to  determine  the  assessed  valuation  of  all  real  estate 
not  owned  by  the  railroad;  assuming  this  amount  to  be 
60  per  cent  of  the  "true  value"  of  the  land,  the  latter 
figure  was  determined.  It  was  then  a  simple  problem  in 
division  to  determine  the  "value"  per  acre;  and  of  multi- 
plication to  apply  this  "value"  to  the  acreage  in  the  rail- 

1  D.  C.  Morgan,  Minnesota  Rate  Cases,  Record  (N.P.),  page  1982. 
8  Ibid.,  page  1994. 

3  Ibid.,  page  1995.    See  Complainant's  Exhibit  65  —  Morgan,  which 
contains  the  data  on  which  the  60  per  cent  was  calculated. 

4  The  size  and  shape  of  these  sections  depended  upon  Mr.  Morgan's 
judgment  as  to  the  equality  of  the  value  of  the  non-railroad  land  adjacent 
to  the  railroad  lands  to  be  valued.   He  was  forced  to  acknowledge  that, 
changing  the  sections,  different  results  would,  of  course,  accrue.  Ibid.t 
page  2345. 

6  Ibid.,  page  1803. 


PHYSICAL  VALUATION  45 

road  property.  Increasing  this  figure  by  the  approved 
multiple,  Mr.  Morgan  arrived  at  the  "cost  of  reproduc- 
tion" of  the  railroad  terminals. 

The  Master  in  this  case,  Mr.  Otis,  was  not  impressed 
that  Mr.  Morgan's  appraisal  was  "entitled  to  much 
weight." l  Did  not  the  sales-assessment  method  ignore  the 
fact  that  "real  estate  values  are  necessarily  and  largely  a 
matter  of  opinion  when  applied  to  any  particular  tract  or 
parcel  of  land"?  2  Mr.  Otis  therefore  looked  to  the  expert 
appraisals  of  the  witnesses  for  the  railroads,  though  pro- 
fessedly keeping  in  mind  "that  witnesses  are  necessarily 
and  unconsciously  influenced  by  the  interests  of  those  at 
whose  instance  they  are  called."  3  And  his  conclusions, 
passed  on  in  perfunctory  fashion  by  Judge  Sanborn,  came 
to  the  Supreme  Court. 

The  Master's  valuation,  for  he  soon  translated  the 
estimated  cost  of  reacquiring  the  land  into  "value,"  repre- 
sented his  own  judgment  as  measured  against  that  of  the 
railroad  witnesses.  For,  though  not  himself  an  expert,  he 
presumed  to  find  that  the  estimates  of  the  railroad  right 
of  way  agents  were  "too  expansive"  and  fixed  upon  figures 
which  were  75  per  cent  of  their  appraisals  for  land  outside 
of  the  terminal  cities.  In  essence  this  meant  a  multiple  of 
two  and  a  quarter,  instead  of  three,  that  applied  by  the 
railroad  right  of  way  men.  Mr.  Otis  presumed  to  make 
this  change  in  the  face  of  a  protest  from  these  experts  that 
even  three  was  too  low,  Mr.  Hayden  of  the  Great  Northern 
having  explained  that  "about  three  times"  had  been  fixed 

1  Report  of  Chas.  E.  Otis,  page  222.  Expert  witnesses  for  the  rail- 
roads considered  the  assessment  figures  "wholly  unreliable"  and  "en- 
titled to  no  practical  consideration."  Minnesota  Rate  Cases,  Record 
(G.N.),  pages  367-68,  569,  580;  (N.P.),  page  3092. 

Indeed  Mr.  Morgan  was  forced  to  acknowledge  that  their  use  was  only 
admissible  on  the  theory  that  applied  to  the  whole  it  would  "work  out" 
what  he  thought  "to  be  the  truth,"  though  "applied  to  the  parts  sepa- 
rately," —  i.e.,  the  sections  into  which  he  divided  the  line,  and  the  area 
on  either  side,  —  he  "would  not  say  that."  Record  (N.P.),  page  1996. 

1  Ibid.,  page  223.  »  Ibid.,  page  222. 


46  RAILROAD  VALUATION 

upon  as  "reasonably  fair"  by  a  conference  of  right  of  way 
men  —  in  which  "  there  were  no  two  persons  hardly  that 
had  the  same  ideal  of  that  percentage."  l 

Mr.  Hayden  confessed  that  in  making  the  "valuation" 
of  right  of  way  between  stations,  he  used  "  principally  his 
own  judgment,"  to  determine  what  it  would  cost  the  rail- 
road; and  arrived  at  a  "market  value"  of  the  lands  by 
dividing  this  figure  by  three.2  In  the  villages  he  took  the 
information  available  as  to  the  value  of  building  sites, 
divided  the  station  ground  "up  into  so  many  town  lots," 
etc.  His  figure  for  "market  value,"  however,  he  conceived 
to  be  the  value  "for  purposes  generally,  not  for  railroad 
purposes,"  both  in  the  villages  and  in  the  open  country.3 
The  basis  of  Mr.  Cooper  of  the  Northern  Pacific,  however, 
was  something  more.  In  his  judgment  the  value  of  rail- 
road land  was  always  higher  than  that  of  adjacent  land. 
But  exactly  how  this  additional  amount  was  to  be  meas- 
ured, except  in  the  judgment  of  an  expert,  his  testimony 
did  not  make  clear.  The  figures  to  which  he  testified,  there- 
fore, represented  his  judgment,  fortified  by  investigation 
of  the  value  of  adjacent  tracts  in  the  few  cases  where  any 
doubt  existed  in  his  mind. 

1  Minnesota  Rate  Cases,  Record  (G.N.),  pages  171-72.    Mr.  Cooper 
testified  to  the  same  effect,  Record  (N.P.),  pages  215,  2*6. 

2  Ibid.,  Record  (G.N.),  page  171. 

8  Ibid.,  page  252.    See  Mr.  Cooper's  testimony  quoted  by  Justice 
Hughes,  Minnesota  Rate  Cases,  230  U.S.  352,  445. 


CHAPTER'!!! 

PHYSICAL  VALUATION— "COST   OF  REPRODUCTION*' 
CAPITAL   GOODS 

Introduction:  The  "contingencies"  allowance,  47. 
I.  The  appraisal  of  plant,  50. 

Practice  in  the  State  and  private  "  valuations,"  51.  —  Task 
of  classification  of  units,  56.  —  Judgment,  59. 
II.  Unit  prices,  61. 

Expert  opinion,  61.  —  Future  prices,  63.  —  Average  prices, 
65.  —  Units  out  of  the  market,  68.  —  "  Average  "  units,  70. 

III.  Overhead  charges,  73. 

Average  percentages,  73.  —  "  Research,"  74.  —  Interest  during 
construction,  76. 

IV.  Deduction  for  depreciation  accrued,  78. 

Obsolescence,    78.  —  Inspection,    80.  —  Life   tables,    81.  — 
Specious  accuracy,  84. 

THE  inclusion  of  a  generous  allowance  for  "contingencies  " 
has  thus  far  been  the  nearest  approach  to  a  frank  acknowl- 
edgment of  the  wide  range  of  error  necessarily  attaching 
to  the  work  of  appraisal.  Such  allowance  being  made, 
totals  have  been  presented  purporting  to  show  results 
accurate  to  the  final  cent.  No  doubt  use  of  the  "contin- 
gencies" allowance  has  represented  simply  the  application 
of  an  expedient  used  in  estimates  of  construction  work  to 
the  task  of  determining  cost  of  reproduction.1  Indeed  the 
justification  of  its  use  in  the  New  Haven  appraisal,  was 
less  that  it  was  meant  to  cover  omissions  of  items  in 
the  existing  plant,  than  to  include  "  many  elements  which 
would  enter  into  the  cost,"  though  "not  represented  in  the 
inventory."  2  The  engineers  who  testified  in  the  Minnesota 

1  Howard  Elliott,  Minnesota  Rate  Cases,  Record  (N.P.),  page  1240; 
the  Valuation  Brief  of  1915,  pages  85-94;  and  Valuation  Conference  of 
May  27-29,  1915,  Proceedings,  pages  45-49. 

2  G.  F.  Swain,  New  Haven  Validation  Report,  page  86.    Among  such 
items  were  included:  "damages  incidental  to  the  work  .  .  .  interfering 


48  RAILROAD   VALUATION 

Rate  Cases  indicated  that  to  them  the  chief  ground  for  in- 
clusion of  "contingencies"  was  the  necessity  to  allow  for 
"all  those  items  which  it  was  impossible  to  see  in  making 
an  approximate  estimate  of  work  already  done,"  as  well  as 
"any  items  that  may  be  overlooked."  l  One  of  the  railroad 
counsel  even  interjected  the  statement,  "There  always 
ought  to  be  put  at  the  foot  of  one  of  these  statements 
'e.  and  o.e.'  —  errors  and  omissions  excepted."  2  But  his 
brief  later  insisted  that  the  figures,  which  he  here  so  quali- 
fied, were  "accurate  and  comprehensive."  3 

The  allowance  which  the  railroad  engineers  testified  to 
as  "customary"  was  ten  per  cent  of  the  amounts  spent 
for  the  permanent  way  and  structures.  Yet  opinion  was 
unanimous  that  this  was  low.  Experience  showed,  they 
declared,  that  unforeseen  costs  ran  "  over  rather  than  under 
ten  per  cent,  and  much  greater  than  ten  per  cent."  4  The 

with  a  farmer's  water  supply  or  cutting  off  access  to  his  land;  temporary 
structures  which  have  been  built  in  the  progress  of  the  work,  but  which 
are  afterwards  removed;  .  .  .  quicksand,  .  .  .  expenses  incident  to  ...  re- 
ducing grades,  involving  lowering  cuts  while  maintaining  traffic,  in 
which  case,  especially  if  the  cut  is  in  rock,  the  expense  is  enormously 
greater  than  it  would  be  to  construct  the  line  in  its  final  form  in  the  first 
instance,"  etc.  See  testimony  of  A.  H.  Hogeland,  Minnesota  Rate  Cases, 
Record  (G.N.),  pages  42-46;  and  the  Valuation  Brief  of  1915,  pages  94- 
102,  "  some  concrete  illustrations." 

1  W.  L.  Darling,  Minnesota  Rate  Cases,  Record  (N.P.),  page  549.  See 
also  his  testimony  at  pages  12  and  69;  that  of  J.  B.  Berry,  ibid.,  pages  739, 
743;  that  of  D.  C.  Morgan,  ibid.,  page  2043;  that  of  J.  F.  Stevens,  Rec- 
ord (G.N.),  page  445.    Mr.  Darling  testified  (page  12):   "We  are  very 
apt  to  leave  out  things  and  forget  things  that  should  be  included,  and 
for  that  reason  I  have  allowed  this  item   of  contingencies  which  is 
generally  allowed." 

The  Valuation  Brief  of  1915  (page  T03)  divides  "contingencies"  into 
two  classes:  (1)  of  construction;  (2)  of  inventory;  and  (page  105)  asserts, 
"  It  is  more  difficult  to  make  an  accurate  estimate  of  the  cost  of  repro- 
duction new  than  the  cost  of  actual  construction  about  to  be  undertaken." 

2  Mr.  Jared  How,  Minnesota  Rate  Cases,  Record  (N.P.),  page  549. 

1  Brief  of  Messrs.  Holden,  How,  Butler,  and  Mitchell  for  the  Com- 
panies, page  311. 

4  J.  B.  Berry,  Minnesota  Rate  Cases,  Record  (N.P.),  pages  739-43; 
also  testimony,  J.  F.  Stevens,  Record  (G.N.),  page  445;  Howard  Elliott. 
Record  (N.P.),  pages  1242-45.  Ten  per  cent  was  used  in  the  Michigan 


PHYSICAL  VALUATION  49 

engineer  for  the  Minnesota  Commission,  however,  insisted 
that  a  five  per  cent  allowance  was  adequate,  since  the 
estimate  was  prepared  "in  the  light  of  known  conditions." l 
G.  F.  Swain,  in  the  New  Haven  appraisal,  though  "per- 
sonally "  believing  that  the  charge  should  be  more  than 
five  per  cent,  used  that  figure.2  In  the  Wisconsin  and  South 
Dakota  appraisals  five  and  a  hah*  per  cent  was  used;  in 
Nebraska,  four  per  cent.3  In  Washington  no  allowance  at 
all  was  made,  the  Chief  Engineer  of  the  State  Commission 
alleging  that "  anybody  that  made  up  or  included  that  item 
showed  his  ignorance."  Or  at  least  the  Chief  Engineer  of 
the  Northern  Pacific,  Mr.  Darling,  so  testified,  and  then 
continued:  "Well,  the  next  day  we  discovered  that  the 
engineer  had  left  out  two  items,  one  of  a  million  and  a 
quarter  dollars  and  the  other  of  a  million  for  work  done  in 
Seattle  and  Tacoma.  Now  that  took  nearly  half  of  the  ten 
per  cent;  so  you  can  see  that  that  is  one  item  that  that 
ten  per  cent  covers.  And,  right  in  my  own  estimate,  I 
left  out  a  million  and  a  half  dollars  of  equipment."  It  was 
here  that  Mr.  How  suggested  his  "errors  and  omissions 
excepted."  4 

The  "contingencies"  allowance  like  the  land  multiple 
is,  then,  an  "  average  "  figure.  Generally  it  has  been  calcu- 
lated upon  the  "cost  of  reproducing"  the  land  as  well  as 

appraisal.  G.  F.  Swain  (the  New  Haven  Validation  Report,  page  86)  said 
that  "while  this  has  by  some  been  considered  as  excessive,  those  in 
charge  of  the  work  believe,  in  the  light  of  their  subsequent  experience, 
that  it  has  been  fully  justified."  In  the  Michigan  appraisal  the  ten 
per  cent  allowance  was  opposed  as  too  large  by  the  railroads,  the 
"valuation"  being  for  taxation  purposes. 

1  D.  C.  Morgan,  Minnesota  Rate  Cases,  Record  (N.P.),  page  1852 
and  following;  see,  however,  the  Valuation  Brief  of  1915,  pages  104-06, 
citing  testimony  to  the  contrary  by  M.  E.  Cooley  and  H.  E.  Riggs  in 
the  Duluth,  South  Shore  &  Atlantic  Passenger  Rate  Case  of  1913. 

2  The  New  Haven  Validation  Report,  page  87.  The  cost  of  "  reproduc- 
ing "  land  was  not  included. 

1  See  Senate  Report  on  Valuation,  page  172. 

4  Minnesota  Rate  Cases,  Record  (N.P.),  page  549.  See  Second  and 
Third  Annual  Reports,  Railroad  Commission  of  Washington,  page  43. 


50  RAILROAD   VALUATION 

the  other  items  of  the  permanent  way,1  and  sometimes  the 
cost  of  "engineering"  has  been  included.  The  variation 
from  the  practice  of  determining  the  contingencies  charge, 
by  taking  a  percentage  of  the  entire  "cost  of  reproducing" 
the  permanent  way  and  structures,  has  not,  however,  been 
significant;  and  for  the  purpose  of  the  present  discussion,  it 
is  enough  to  point  out  that  the  factor  of  .judgment  and 
opinion  has  here  had  the  fullest  scope.  No  attempt  has 
been  made,  therefore,  to  determine  what  percentage  should 
be  allowed  for  "contingencies"  upon  each  set  of  items. 
Individual  cases  might  show  cost  running  fifty,  even  a 
hundred  per  cent  above  the  estimate.2  But  though  the 
percentage  would  not  apply  uniformly  to  all,  the  "total 
contingencies,"  it  has  been  assumed,  would  equal  the 
amount  found  by  applying  an  "average"  figure  to  the 
"total  of  the  items  .  .  included."  3 


The  work  of  the  engineer  in  making  the  inventory  of  the 
plant  necessarily  involves  dependence  upon  individual 
judgment,  even  upon  the  intelligent  use  of  the  imagination 
at  every  step.  Before  the  task  of  measurement  and  com- 
putation can  be  taken  up,  the  natural  conditions  met  at 
the  time  of  original  construction  must  be  conceived  of  as 
restored.  This  is  necessary  that  the  actual  engineering 
task  faced  in  the  beginning  may  be  "reproduced."  To 
measure  the  acreage  of  "clearing  and  grubbing,"  the  areas 

1  The  Valuation  Brief  of  1915  (page  103)  declares:  "While  all  engi- 
neers agree  that  a  substantial  allowance  must  be  made  to  cover  con- 
tingencies, it  may  be  said  that  the  engineering  valuation  practice  is  not 
definitely  settled  as  to  the  amount  of  the  item,  or  the  manner  of  adding 
the  allowance." 

z  D.  C.  Morgan,  Minnesota  Rate  Cases,  Record  (N.P.),  page  2044. 

3  J.  B.  Berry,  ibid.,  page  894.  Here  the  figure  was  ten  per  cent.  See 
testimony  of  J.  F.  Stevens,  Record  (G.N.),  page  446.  Mr.  Stevens 
here  spoke  of  the  "  percentage  of  contingency  ...  an  allowance  .  .  .  for 
the  ignorance  of  the  profession." 


PHYSICAL  VALUATION  51 

covered  with  trees  and  underbrush  must  be  determined. 
The  original  contour  of  the  land  must  be  restored  in  order 
that  the  yardage  of  cut  and  fill  may  be  measured.  Swamps 
long  since  drained,  or  streams  turned  from  their  original 
beds,  must  present  the  difficulties  surmounted  by  the  con- 
structing engineers.  Given  this  setting  for  his  work,  the 
engineer's  task  is  to  determine  what  would  be  the  cost  of 
duplicating  the  road.1  Assuming  preliminary  and  location 
surveys  made  (their  cost  has  universally  been  measured, 
like  the  "contingencies"  charge,  on  a  percentage  basis), 
the  work  of  inventory  is  begun. 

In  the  "valuations"  made  by  the  States  it  has  not  been 
the  practice  of  the  engineer  to  take  his  instruments  onto 
the  right  of  way,  and  there  to  make  detailed  measurements. 
Field  work  of  this  nature  has  been  resorted  to  only  in  the 
entire  absence  of  office  records  in  the  engineering  depart- 
ments of  the  roads.  Instead  figures  have  been  drawn  from 
the  records,  and  subjected  to  the  more  or  less  superficial 

1  Several  of  the  questions  discussed  at  the  Valuation  Conference  of 
May  27-29,  1915,  bear  upon  the  topics  discussed  in  this  paragraph: 

Question:  "  Shall  an  allowance  be  made  for  clearing  and  grubbing,  and 
if  so,  shall  it  be  allowed  where  the  road  runs  through  what  is  now  tillage 
land,  but  what  was  at  the  time  of  construction,  a  forest?  " 

Railroads:  "Yes." 

State  Commissioners:  "  No,  if  adjacent  land  is  tillage  land;  yes,  if  adja- 
cent land  is  now  forest  land  and  is  so  valued;  no,  if  adjacent  land  has 
been  cleared  and  grubbed  and  now  valued  as  such;  wherever  allowance 
is  made  for  clearing  and  grubbing,  the  value  of  the  wood  should  be  offset. 
If  adjacent  land  is  cleared  and  not  grubbed,  allowance  should  be  made 
for  grubbing  only." 

Question:  "Are  present  geological  and  topographical  conditions  to  be 
taken,  or  is  inquiry  to  be  made  as  to  what  these  conditions  were  at  the 
time  of  original  construction?  " 

Railroads:  "  In  considering  the  structural  features  of  reproduction  .  .  . 
conditions  should  be  assumed  to  be  as  of  the  time  of  the  original  construc- 
tion, except  where  they  have  subsequently  been  altered  over  areas  entail- 
ing considerable  additional  construction  difficulties  which  were  met  by 
the  railroad  from  time  to  time  as  they  arose." 

Commissioners:  "Present  conditions  should  be  taken,"  etc. 

Proceedings,  page  7  and  following;  see  the  Valuation  Brief  of  1915, 
pages  63-68. 


52  RAILROAD  VALUATION 

check  of  "expert"  inspection.  In  Michigan  and  Washing- 
ton the  inspection  of  records  was  made  by  State  employees ; 
in  other  cases,  following  the  precedent  set  in  Wisconsin,  the 
railroads  themselves  furnished  the  preliminary  figures. 
Were  the  engineering  records  to  be  accepted  as  correct, 
even  perfunctory  field  work  could  be  eliminated.  The 
measurement  would  be  a  clerical,  not  an  engineering,  task. 
The  very  fact  that  records  are  so  concededly  inadequate 
as  to  compel  resort  to  other  authority  demands,  it  would 
seem,  the  most  careful  and  painstaking  measurements.1 

These  State  appraisal  figures,  though,  like  those  pre- 
sented by  the  railroads  as  "evidence"  in  rate  cases,  offering 
results  set  down  as  if  accurate,  have  never  been  deter- 
mined by  resurvey.  Mr.  Morgan,  the  Minnesota  Chief 
Engineer,  testified  that  the  essential  distinction  between 
his  work  and  that  of  Mr.  Taylor  in  Wisconsin,  and  of 
Mr.  Cooley  in  Michigan,  lay  in  the  "  thoroughness  of  the 
work." 2  Description  of  his  plan — in  essentials  followed  in 

1  J.  F.  Stevens,  who,  at  the  time  of  testifying  in  the  Minnesota  Rate 
Cases,  was  Vice-President  of  the  New  Haven  (he  had  been  Chief  Engineer 
of  the  Great  Northern,  of  the  Rock  Island,  and  of  the  Panama  Canal), 
declared  that  the  Great  Northern  had  "  probably  the.best  set  of  engineer- 
ing records  in  the  United  States,  or  among  the  best."  Record  (G.N.), 
page  426.    As  regards  grading  quantities  these  records  showed  73  per 
cent  of  the  yardage;  and  of  the  remaining  27  per  cent  of  the  total  as 
estimated,  23  per  cent  was  estimates  from  profiles;  and  4  per  cent  was 
determined  from  the  "knowledge  of  the  lines"  possessed  by  the  Chief 
Engineer,  Mr.  Hogeland.    See  his  testimony,  ibid.,  page  15.    If  these 
are  records,  "  superior  to  any  in  the  United  States,"  it  would  seem  that 
entire  dependence  on  records  would  be  quite  out  of  the  question.    The 
incomplete  character  of  the  railroad  records  was  generally  certified  to 
at  the  Valuation  Conferences  between  the  Engineers  representing  the 
Commission  and  those  representing  the  railroads,  held  September  4-5, 
and  October  14-15,  1913. 

2  Minnesota  Rate  Cases,  Record  (N.P.),  page  1975.    Mr.  Morgan 
described  some  work  which  he  did  as  an  employee  of  the  C.  St.P.M. 
&  O. :  "  We  divided  the  line  into  some  seventeen  sections  in  the  State  of 
Wisconsin,  and  the  authorities,  after  receiving  the  report,  shook  up  the 
numbers  of  the  sections  in  a  hat  and  picked  out  a  number,  and  that  was 
the  number  of  the  section  which  they  went  out  to  examine;  and  if  they 
found  the  conditions  right  on  that  section,  they  assumed  that  it  was  right 
on  the  entire  system." 


PHYSICAL   VALUATION  53 

South  Dakota  and  Nebraska  —  indicates  that  "thorough" 
was  still  a  relative  term  in  Mr.  Morgan's  mind.  The  rail- 
roads furnished  figures  of  quantities  based  upon  their 
records,  and  these  were  checked  by  Mr.  Morgan  and 
several  assistants.  This  official  inspection  was  made  from 
a  train  "  moved  at  a  low  rate  of  speed,  so  that  observation 
could  be  had  of  the  character  and  standards  of  construction 
and  maintenance."  To  be  sure,  "stops  were  made  every 
mile  in  places,  but  usually  every  two  miles,  and  sometimes 
every  five  miles.  ...  A  day's  work  of  ten  hours  enabled  an 
average  inspection  of  about  one  hundred  miles."  l  Strange 
as  it  may  seem,  even  this  almost  casual  inspection  did 
show  some  gross  inaccuracies  in  the  railroad  figures.2 

Nor  would  covering  twelve  miles  a  day  on  foot,  or 
twenty-five  miles  on  a  hand  car,  "stopping  for  occasional 
measurements,"  promise  results  necessarily  conclusive.3 
Perhaps  a  greater  degree  of  accuracy  is  attained  than  where 
entire  dependence  is  placed  upon  the  "  judgment,"  "  knowl- 
edge," "experience"  of  the  chief  engineer  of  a  large  rail- 
road. But  it  would  be  difficult  to  generalize.  When  Mr. 
Darling,  of  the  Northern  Pacific,  was  directed  to  determine 
the  "cost  of  reproduction"  of  that  road  for  use  in  the 
Spokane  Case,  he  increased  the  quantities  appearing  on  the 
records  by  twenty  per  cent  to  take  account  of  changed  con- 
struction standards.  The  figure  used  as  a  basis  did  not 

1  Supplement,  Report,  Minnesota  Railroad  &  Warehouse  Commission, 
1908,  page  23.    Inspection  from  a  slow-moving  train  had  been  used  by 
Mr.  Morgan's  father,  R.  P.  Morgan,  in  the  appraisal  for  the  Pacific 
Railway  Commission.     See  Senate  Executive  Document  51,  50th  Con- 
gress, 1st  Session,  page  4469.    See  testimony  of  J.  J.  Hill,  Minnesota 
Rate  Cases,  Record  (G.N.),  pages  1251-52;  of  A.  H.  Hogeland,  ibid., 
page  1647;  and  the  Brief  for  the  Companies,  pages  306-07. 

2  See  testimony  of  D.  C.  Morgan,  Minnesota  Rate  Cases,  Record 
(G.N.),  pages  1389-90;  of  W.  L.  Darling,  Record  (N.P.),  page  91;  and 
Mr.  Morgan's  letter  addressed  to  President  Elliott,  Defendant's  Exhibit 
B.   Mr.  Darling  testified  that  the  report  submitted  the  State  had  not 
been  "checked  or  edited." 

3  See  Report  of  H.  P.  Gillette,  Chief  Engineer,  to  the  Washington 
Railroad  Commission,  Second  and  Third  Annual  Reports,  page  47. 


54  RAILROAD  VALUATION 

represent  a  resurvey,  but  was  based  on  profiles,  etc.1  And 
the  arbitrary  twenty  per  cent  was  chosen  in  "probably  an 
hour."  It  was  "a  mere  matter  of  calculation,"  "simply 
a  matter  of  judgment,"  2  "just  as  accurate  as  anybody 
can  possibly  get  it  with  the  very  best  of  judgment."  3  In 
the  Spokane  Case,  too,  the  Chief  Engineer  of  the  Great 
Northern  testified  that  the  records  of  the  Company 
showed  quantities  in  the  case  of  82  per  cent  of  the  entire 
system,  and  that  a  "very  close  estimate  could  be  made  of 
the  remaining  18  per  cent."4  Commissioner  Prouty  could 
therefore  speak  of  the  Northern  Pacific  "valuation"  as 
"by  no  means  a  guess,"  5  though  that  of  the  Great  North- 
ern was  "more  satisfactory."  He  was  "impressed"  that 
this  estimate  had  been  prepared  in  good  faith  and  with 
great  care.6  It  would  here  seem  difficult  to  draw  the  line 
between  "guessing"  and  making  an  expert  judgment.7 

That  such  inconclusive  figures  —  inconclusive  from  the 
viewpoint  of  statistical  accuracy  —  should  have  passed 
through  the  hands  of  the  Interstate  Commerce  Commis- 
sion without  severe  condemnation  would  seem  almost 
incredible.  But  how  much  more  worth  while  a  check  made 
from  the  platform  of  a  slowly  moving  train  would  have 
been  must  necessarily  be  difficult  to  say.  Mr.  Darling  in- 
sisted that  the  only  way  a  more  accurate  measurement 

1  The  figures  used  as  a  base  were  simply  estimates  made  at  the  time  of 
the  reorganization  of  1898.  Spokane  ».  N.P.  Ry.  Co.,  15  I.C.C.  37C,  395. 
See  Mr.  Darling's  testimony,  Minnesota  Rate  Cases,  Record  (N.P.), 
pages  80-81. 

2  Minnesota  Rate  Cases,  Record  (N.P.),  page  82. 
8  Ibid.,  page  81 ;  also,  pages  33  and  48. 

4  Spokane  v.  N.P.  Ry.  Co.  15  I.C.C.  376,  402.  The  18  per  cent  refers 
to  mileage.  How  large  a  proportion  of  this  lay  in  a  mountain  country  is  a 
significant  detail,  here  untouched. 

6  Ibid.,  page  396.  The  Valuation  Brief  of  1915  (page  339)  quotes  this 
assertion  with  apparent  satisfaction. 

6  Spokane  v.  N.P.  Ry.  Co.,  15  I.C.C.  376,  402. 

7  Mr.  Melcher,  of  the  Rock  Island,  "guessed  in  his  judgment"  —  his 
guess  being  "analogous  to  judgment "  —  that  it  would  cost  $404,000,000 
to  reproduce  that  road  in  1910.  Evidence,  1910  Advances,  pages  265-67. 


PHYSICAL  ^VALUATION  55 

could  be  secured  than  that  accorded  by  his  twenty  per 
cent  allowance  was  by  the  slow  process  of  measurement.1 
Perhaps  he  was  right.  It  is  for  the  engineering  profession 
to  give  the  verdict. 

Yet  it  cannot  be  said  that  engineers  have  appeared 
willing  to  accept  resurvey  figures  as  in  any  sense  insuring 
accuracy.  Mr.  Gillette,  the  engineer  in  charge  of  the 
Washington  appraisal,  expressed  himself  in  the  following 
vigorous  language:  "An  attempt  to  estimate  by  field  sur- 
vey should  be  the  last  resort,  not  only  on  account  of  the 
greater  cost  of  field  work,  but  because  of  its  greater  in- 
accuracy, and  finally  —  but  not  to  be  ignored  —  because, 
in  a  legal  dispute  as  to  the  estimated  cost,  field  surveys  and 
estimates  made  by  different  engineers  are  likely  to  differ 
widely  ...  a  field  survey  should  be  used  only  as  a  last 
resort."  2  Asked  in  the  Minnesota  Rate  Cases  whether  con- 
struction did  not  sometimes  so  destroy  the  original  condi- 
tions that  it  was  now  impossible  to  estimate  what  work  had 
been  done,  Mr.  Morgan  answered  in  the  affirmative,  "  un- 
questionably." 3  Without  records,  a  larger  percentage  for 
contingencies  would  be  necessary.  The  engineers  of  the 
railroads  and  Mr.  J.  J.  Hill  testified  to  the  same  conclusions. 
Equally  unanimous  were  they  as  to  the  inadequacy  of 
estimates  made  from  profiles.4  A  profile  "  simply  shows  a 
vertical  section  through  the  roadbed,  the  ground  line  and 
the  grade  line  both  showing,  so  as  to  determine  where  the 

1  Minnesota  Rate  Cases,  Record  (N.P.),  page  81. 

2  Second  and  Third  Annual  Reports,  Railroad  Commission  of  Washing- 
ton, page  47. 

The  Valuation  Brief  of  1915  insists  that  "  original  records,  when  cor- 
roborated, furnish  better  evidence  than  present  measurements."  (Dis- 
cussed at  length,  pages  54-61.) 

3  Minnesota  Rate  Cases,  Record  (N.P.),  page  2045.   See  the  Valua- 
tion Brief  of  1915,  pages  105-08. 

4  W.  L.  Darling,  Minnesota  Rate  Cases,  Record  (N.P.),  page  49;  J.  F. 
Stevens,  Record  (G.N.),  page  429;  J.  J.  Hill,  ibid.,  page  1252.   Mr. 
Stevens  testified,  Record  (G.N.),  page  429,  "  as  a  rule  you  underestimate 
always  with  a  profile  estimate."    Mr.  Hogeland,  ibid.,  page  1650,  showed 
that  his  figures  based  on  profiles  had  been  increased  ten  per  cent. 


56  RAILROAD  VALUATION 

cuttings  and  fills  exist."  But  it  does  not  show  "the  width 
of  roadbed"  or  "the  nature  of  the  ground."  Where  the 
records  are  incomplete,  such  information  "generally  comes 
from  personal  knowledge."  l 

If  the  problem  be  one  of  measurement  alone,  therefore, 
it  can  hardly  be  said  that  the  determination  of  grading 
quantities  is  one  permitting  more  than  the  broadest  ap- 
proximation. The  burden  of  restoring  the  difficulties  met 
at  the  time  of  construction  necessarily  involves  this  limita- 
tion. Even  with  the  physical  contour  restored,  it  would 
still  be  necessary  to  estimate  the  amount  of  earth  "lost"  in 
building  an  embankment  across  a  swamp;  the  cost  of  extra 
labor  occasioned  by  the  falling  of  tunnel  walls  —  unless, 
to  be  sure,  these  are  to  be  allowed  for  in  the  "contingen- 
cies" charge.  Even  with  accurate  figures  of  yardage  the 
responsibility  would  remain  of  determining  how  the  work 
would  be  handled,  whether  by  steam  shovel  or  by  team; 
of  calculating  the  amount  of  overhaul,  of  "waste,"  of 
"borrow."2 

And  there  would  be  the  final  task  of  "classifying"  the 
materials,  as  earth,  loose  rock,  solid  rock,  etc.  Even  in  con- 
struction work  this  is  recognized  as  "estimating."  What 
must  it  be  when  the  attempt  is  to  determine  the  "cost  of 

1  A.  H.  Hogeland,  Minnesota  Rate  Cases,  Record  (G.N.),  pages  1644-45. 
See  Mr.  Darling's  testimony:  "Those  things  you  have  got  to  have  judg- 
ment for,  you  have  got  to  know  the  conditions  under  which  the  line  was 
built."  Record  (N.P.),  page  50. 

2  In  the  New  Haven  Appraisal,  conducted  under  the  direction  of  G.  F. 
Swain  (where  J.  F.  Stevens'  appraisal  made  for  the  New  Haven  was 
checked),  "  the  inspection  of  the  lines  owned  occupied  a  period  of  twelve 
days  with  a  special  train."   New  Haven  Validation  Report,  page  78.  The 
work  was  largely  one  of  checking  profiles,  and  changes  were  effected  by 
calculating  that  different  methods  of  handling  the  construction  work 
would  be  used  from  those  assumed  by  Mr.  Stevens.    The  Swain  report, 
eliminating  overhaul  and  train-haul  entirely,  increased  the  amount  of 
"borrow,"  etc.    That  significant  changes  in  result  could  be  effected 
through  this  process  is  indicative  of  a  further  dependence  upon  "  judg- 
ment." See  the  New  Haven  Validation  Report,  page  76,  and  also  the  testi- 
mony of  D.  C.  Morgan,  Minnesota  Rate  Cases,  Record  (N.P.),  page 
2113,  on  steam-shovel  work,  etc. 


PHYSICAL  VALUATION  57 

reproducing"  cuts  and  fills  where  the  work  was  done  ten, 
twenty,  fifty  years  ago 1  —  when  the  sides  of  cuts  are  over- 
grown, when  rock  has  slid  from  place  ?  Can  inspection  ex- 
pose quicksand,  which  to-day  appears  no  different  from 
"straight  earth"?  Is  there  wonder  that  Mr.  Darling 
testified :  "  You  can't  get  at  the  classification  "(accurately)  ? 
Equal  elements  of  uncertainty  attach  upon  much  the 
same  grounds  to  the  estimates  of  the  amount  of  rock  in 
protection  work,  tunnel  linings,  bridge  piers,  etc.;  or,  if 
construction  be  of  later  date,  the  quality  and  quantity  of 
concrete.  In  the  case  of  pile  bridges,  the  length  of  piling 
and  of  bridge  timbers  must  be  estimated;  or,  where  tem- 
porary trestles  have  been  built  in  order  to  cross  a  low 
stretch  of  ground  where  dirt  was  later  hauled  in,  the 
amount  so  used  must  be  approximated.  And  there  are  the 
small  culverts  and  drain  pipes. 

But  assume  the  measurement  of  the  roadbed  and  bridges 
completed.  The  amount  of  track  laying  and  "surfacing" 
(labor  costs,  in  large  degree,  usually  estimated  by  the  mile) 
is  yet  to  be  determined;  the  number  and  weight  of  rails; 
the  number  and  quality  of  ties;  the  track  fastenings;  the 
ballast.  Even  in  the  case  of  ties,  rails,  frogs,  track  fasten- 
ings, where  the  task  might  seem  to  be  one  of  mere  counting, 
the  problems  of  classification  are  complicated.2  But  to 

1  D.  C.  Morgan,  Minnesota  Rate  Cases,  Record  (G.N.),  pages  1384-95. 
See  testimony  of  W.  L.  Darling,  Record  (N.P.),  page  50. 

Yet  he  made  a  classification,  relying  upon  his  "  judgment  "  and  "  gen- 
eral knowledge  of  the  situation."  Ibid.,  page  86.  As  good  a  case  as  any  of 
classification  based  on  casual  inspection  is  shown  in  the  New  Haven 
Validation  Report,  pages  76  and  78.  Here  the  volume  of  solid  rock  was 
increased  over  a  million  yards,  —  from  7,277,677  to  8,380,408  cubic 
yards,  —  on  the  basis  of  inspection  from  a  train,  etc.  Yet  the  figures 
were,  as  usual,  set  down  as  though  accurate.  See  also  the  Valuation 
Brief  of  1915,  pages  48,  49,  98. 

2  For  example,  ties  must  be  classified  according  to  the  kind  of  wood, 
the  grade  in  each  case  (the  standards  of  the  American  Railway  Engineers, 
for  example,  specify  the  measurement  of  No.  1,  No.  2,  culls,  etc.);  whether 
treated  or  untreated,  and  if  the  former,  by  what  process;  while  really 


58  RAILROAD  VALUATION 

indicate  these  in  detail  would  encroach  upon  the  engineer- 
ing aspects  of  the  subject.  It  is  enough  to  notice  that  more 
is  needed  than  a  mere  count;  that  "judgment"  is  essential 
in  establishing  the  specifications  for  various  grades,  what- 
ever the  "unit"  considered,  and  in  seeing  that  the  inven- 
tory represents  an  intelligent  grouping  of  these  items.  Some 
of  the  most  difficult  problems  are  met  in  an  estimate  of  the 
amount  of  grading;  but  the  element  of  uncertainty  extends 
beyond  this.1  The  same  complications  appear,  too,  in 
appraisal  of  the  permanent  structures.  These  include  such 
different  buildings  as  freight  and  passenger  stations,  office 
buildings,  signal  towers,  engine  houses,  shops, power  plants, 
water  tanks,  coal  stations,  etc.  Here  the  task  of  inventory 
demands  an  estimate  of  materials  and  of  the  amount  of 
labor  necessary  for  the  work  of  construction  in  each  indi- 
vidual case.  Unless,  to  be  sure,  the  practice  of  Mr.  Darling 
in  his  "valuation"  for  the  Spokane  Case  be  adopted  of 
idealizing  an  "average"  structure,  and  permitting  this 
task  of  inventory  to  degenerate  to  one  of  mere  counting.2 

accurate  classification  would  include  also  whether  the  ties  were  hewn, 
or  sawed,  and  whether  made  from  a  whole  tree-trunk  (pole  ties); 
from  a  half,  or  a  quarter,  etc.  Rails  do  not  present  so  complicated  a 
group  of  detail  factors,  the  standard  for  each  material  (iron,  steel,  tita- 
nium, etc.)  being  in  terms  of  pounds  per  lineal  yard;  but  frogs,  track 
fastenings,  spikes,  tie  plates,  switches  are  of  numerous  varieties  (some 
patented),  etc. 

1  See  testimony  of  W.  L.  Darling,  Minnesota  Rate  Cases,  Record 
(N.P.),  pages  3207-47,  a  comparison  of  his  figures  for  the  Minnesota 
lines  with  those  used  by  Mr.  Morgan. 

2  "  I  had  to  get  an  average  water  station  "  (ibid.,  page  41).  For  round- 
houses, he  made  a  count  of  "stalls"  (page  42).     On  shop  buildings, 
however,  the  unit  of  count  was  in  terms  of  square  feet,  not  of  board  meas- 
ure, or  the  volume  of  brick.     It  may  be  said,  of  course,  that  on  most 
roads,  if  not  all,  there  are  standard  station  house  plans  which  are  used 
over  the  line;  definite  specifications  for  water  stations,  and  section  houses, 
etc.  But  a  considerable  number  of  the  structures  (one  could  not  venture 
to  estimate  how  many)  stand  in  a  class  alone.    Engine  terminals  have 
been  expanded  to  meet  growing  needs;  additions  have  been  built  to 
office  buildings;  a  station  has  been  designed  to  meet  peculiar  conditions. 
To  determine  upon  the  quantities  of  materials  contained  in  these  struc- 
tures (in  the  absence  of  the  detailed  plans)  would  call  for  eyes  of  super- 
natural power. 


PHYSICAL  VALUATION  59 

Turn  now  to  the  equipment  items:  locomotives,  pas- 
senger and  freight  cars,  work  trains.  It  is  here  that  the 
railroad  records  are  most  complete,  and  the  work  is  largely 
one  of  checking.  Even  the  fact  that  there  are  a  large 
number  of  different  locomotive  types  used  side  by  side 
(or  classes  of  cars)  simply  means  a  more  detailed  grouping. 

This  brief  sketch  of  the  wide  scope  of  the  appraisal 
serves  to  indicate  only  the  broadest  outlines  of  a  problem 
requiring  technical  skill  of  the  highest  order.  Many  of  the 
details  lie  peculiarly  in  the  domain  of  the  civil  engineer,1 
many  in  that  of  the  mechanical  engineer,2  not  a  few  in 
that  of  the  electrical  engineer.3  Necessarily  any  inventory 
based  entirely  upon  expert  opinion  —  "judgment"  —  is 
subject  to  a  significant  range  of  error  even  in  the  work  of 
measurement  and  count.  When  the  further  requirement  of 
classification  is  seen  as  a  prerequisite  to  any  intelligent 
attempt  at  inventory,  the  degree  of  this  error  promises  to 
be  much  greater.  In  the  case  of  the  permanent  way  depend- 
ence upon  expert  knowledge  appears  most  strikingly,  since 
it  is  here  that  the  great  work  of  "imagining"  (there  is  no 
other  word)  the  conditions  met  at  the  time  of  construction 
appears.  But  that  results  more  conclusive  are  secured 
by  measurements  of  all  structures  (including  bridges)  is 
doubtful.  And  though,  in  the  case  of  ties,  rails  (and  every 
item  of  the  track  superstructure  except  ballast),  the  im- 
agination is  relieved  of  its  burden,  a  premium  is  placed 
upon  accurate  judgment  and  painstaking  measurement  in 
the  choosing  and  grouping  of  classifications.4  But  as  be- 
tween fixing  upon  the  amount  of  seventy-pound  or  eighty- 

1  The  permanent  way  and  structures,  etc.  See,  for  example,  "  Instruc- 
tions for  Building  Field  Parties,"  for  the  "  Field  Work  of  the  Roadway 
and  Track  Department,"  and  for  the  "Bridge  Field  Parties,"  issued  by 
the  Division  of  Valuation,  I.C.C. 

2  Rolling  Stock,  shop  equipment,  etc. 
8  Power  plants,  signal  apparatus,  etc. 

4  See  the  "  Instructions  for  the  Field  Work  of  the  Roadway  and  Track 
Department,"  Division  of  Valuation,  I.C.C. 


60  RAILROAD   VALUATION 

pound  rail  in  a  stretch  of  track,  and  determining  what 
portion  of  a  cut  of  fifty  thousand  cubic  yards  should  be  paid 
for  as  earth,  as  loose  rock,  or  as  solid  rock,  there  is  no 
question  of  the  relative  simplicity  of  the  former.  In  either 
case,  —  in  any  case,  —  everything  must  be  placed  entirely 
in  the  hands  of  experts,  with  the  hope  that  engineering 
practice  will  give  the  best  it  has. 

That  such  has  not  been  given  in  the  past,  there  can 
hardly  be  doubt.  The  engineering  work  of  the  State  ap- 
praisals, to  the  layman  at  least,  would  seem  almost  per- 
functory when  the  extent  of  the  issues  involved  is  realized. 
Whether  the  work  of  resurvey,  etc.,  can  promise  results 
necessarily  more  significant  than  those  secured  by  the 
States,  or  those  presented  by  railroad  engineers  as  based 
upon  their  experience  or  judgment,  is  an  issue  which  must 
be  left  with  the  engineering  profession  to  decide.  If  not,  we 
are  at  the  point  where  in  frankness  we  should  say  of  the 
results:  they  are  an  engineering  guess;  nothing  else  can  be 
hoped  for.  The  Wisconsin  Commission,  it  would  seem, 
bowed  to  the  inevitable  when  it  admitted  that  "in  ap- 
praisals .  .  .  there  are  many  points  upon  which  the  facts 
are  not  clear,  and  which  of  necessity  are  matters  of  judg- 
ment," where  the  appraisers  are  "often  justified  in  giving 
their  clients  the  benefit  of  the  doubts."  l  How  such  a  policy 
could  be  expected  to  work  out  were  one  set  of  witnesses 
only  "moderately  expert'*  while  another  set  possessed 
qualifications  which  were  "  indisputable  and  of  the  highest 
order,"  must  remain  a  matter  of  speculation.2  It  is  enough 
for  the  purpose  of  the  present  discussion  to  indicate  that  no 
appraisal  results  can  profess  to  represent  accuracy.  And 
this  holds  true  entirely  aside  from  any  consideration  of  the 
unit  prices  which  are  applied  to  the  "quantities"  in  order 
to  translate  these  into  terms  of  dollars  and  cents. 

1  Milwaukee  v.  M.E.R.  &  L.  Co.,  10  W.R.C.R.  1,  87. 

2  Brief  for  the  Company,  page  57;  Knoxville  v.  Knoxville  Water  Co., 
212  U.S.  1. 


PHYSICAL  VALUATION  61 

II 

It  must  be  emphasized  that,  in  a  study  of  "physical 
valuation'*  from  the  economic  point  of  view,  there  cannot 
be  a  detailed  consideration  of  the  "unit"  prices  for  each 
item  of  the  inventory.  It  is  principle,  and  not  detail,  that 
is  significant.  The  work  of  defining  the  specifications  for 
the  "units  of  cost"  demands  expert  engineering  ability.1 
So  also  does  that  of  fitting  prices  to  these  specifications  as 
chosen.  In  fact,  the  unit  prices  necessarily  vary  with  a 
change  in  specifications  covering  the  "units  of  cost."  In 
the  hands  of  a  second  engineer,  though  the  same  piece  of 
plant  be  under  view,  a  different  set  of  specifications  (and 
the  different  set  of  unit  prices  thereby  made  inevitable) 
might  be  used.  It  is  even  conceivable  that  both  men  should 
get  the  same  final  total,  though  using  a  different  basis  of 
calculation  —  however  improbable  such  a  result  would 
appear.2  At  all  events,  the  weakness  attaching  to  expert 
opinion  (or  call  it  "knowledge,"  "judgment,"  "intuition") 
is  always  present,  whether  the  degree  of  error  be  con- 
ceived as  large  or  small. 

For  unit  prices  depend  entirely  upon  the  personal  judg- 
ment of  the  expert  who  chooses  them.  No  matter  how  de- 
tailed an  examination  of  cost  data  may  be  made,  the  fact 
remains  that,  since  the  unit  prices  and  classification  stand- 

1  "Units  of  cost"  are  the  physical  units  for  which  the  unit  "prices'* 
or  unit  "costs"  are  fixed.  Testimony  of  D.  C.  Morgan,  Minnesota  Rate 
Cases,  Record  (N.P.),  page  1780. 

2  For  example,  assume  a  cut  containing  50,000  cubic  yards.    One 
engineer,  using  a  "rock"  price  of  $1  per  yard,  a  "loose  rock"  price  of 
50  cents,  and  an  "earth  price"  of  25  cents,  "classifies"  the  contents  as 
50  per  cent  "solid  rock";  30  per  cent  "loose  rock";  20  per  cent  "  earth." 
This  gives  him  a  total  of  $35,000  for  the  cost  of  excavation.    Another 
engineer,  using  only  "rock"  prices  and  "earth"  prices  (under  "earth" 
grouping   everything  except  "solid   rock"),  classifying  the  quantities 
50-50  would  get  the  same  total  cost  by  using  an  "earth"  price  of  40  cents. 
For  further  illustrations,  see  testimony  of  W.  L.  Darling,  Minnesota 
Rate  Cases,  Record  (N.P.),  page  3209;  the  New  Haven  Validation  Re- 
port, page  78;  and  the  Valuation  Brief  of  1915,  page  129. 


62  RAILROAD   VALUATION 

ards  (as  well  as  the  methods  of  work)  must  be  correlated, 
every  price  ultimately  depends  upon  expert  opinion.  The 
question  is  not  one  of  relatively  accurate  or  inaccurate 
results,  as  is  the  case  with  measurements,  but  one  of  the 
entire  adequacy  of  the  figures  finally  presented.' Though 
an  accurate  inventory  of  physical  quantities  were  secured, 
a  different  choice  of  unit  prices  would  cause  variation  in  the 
"valuation"  figure.1  Three  distinct  bases  for  "cost  of 
reproduction"  have  been  proposed:  (1)  prices  presumably 
obtaining  through  a  future  construction  period;  (2)  "pres- 
ent prices";  (3)  average  prices  over  a  period  of  years. 

In  view  of  the  large  variety  of  "units"  in  the  inventory 
of  a  railroad,  and  the  large  number  of  standards  and  classi- 
fications under  each,  it  is  clear  that  an  extremely  difficult 
technical  problem  is  here  presented.  One  can  be  very 
skeptical  of  the  validity  of  the  assertion  (though  made  by 
an  "expert")  that  "the  determination  of  the  proper  prices 
...  is  not  a  very  complicated  matter,"  since  "an  average 
figure  based  on  proper  experience  and  judgment  may  prove 
as  satisfactory  as  a  figure  laboriously  worked  out  from  a 
mass  of  varying  data."  Though  perhaps  there  may  always 
be  "opportunity  for  abbreviating  the  work  by  due  con- 
sideration of  this  matter  by  a  competent  expert,"  2  the 
difficulty  in  the  past  has  been  to  get  experts  able  to 
"  average  "  qualities,  prices,  and  judgment,  with  any  degree 
of  unanimity.  "Proper  experience,"  "due  consideration," 
"competency,"  are  noncommittal  phrases.  The  situation 
should  be  frankly  faced.  Unit  prices  used  in  making  "cost 
of  reproduction  "  estimates  have  been  based  upon  personal 
opinion.  The  error  always  attaching  to  work  of  such 
character  attaches  to  any  unit  prices  adopted  upon  that 

1  "Two  engineers  may  undertake  the  appraisal  of  the  same  property, 
use  methods  which  seem  perfectly  fair  to  each,  and  arrive  at  results  differ- 
ing as  much  as  20  per  cent  or  30  per  cent."  W.  D.  Taylor,  Chief  Engineer 
of  the  Wisconsin  Appraisal,  Transactions,  Am.  Soc.,  C.E.,  volume  52, 
page  354. 

2  Henry  Floy,  Valuation  of  Public  Utility  Properties,  pages  62-63. 


PHYSICAL  VALUATION  63 

basis.  The  limitation  is  one  inherent  in  the  problem.  And 
it  is  not  one  to  be  glossed  over  by  resort  to  generality. 

"Cost  of  reproduction"  presuming  to  prophesy  the 
probable  course  of  future  prices  has  been  the  exceptional 
basis.  Yet  the  "valuation"  which  Commissioner  Prouty, 
accepting  a  volume  of  detail  as  evidence  of  accurate  and 
careful  work,  called  "by  no  means  a  guess,"  —  that  pre- 
sented by  the  Northern  Pacific  in  the  Spokane  Case,  —  was 
predicated  upon  such  attempt  at  prophecy.  We  have  al- 
ready seen  that  the  "quantities"  came  from  records  con- 
fessedly incomplete,  an  arbitrary  allowance  of  twenty  per 
cent  having  been  added  in  the  case  of  grading  (the  choice  of 
this  figure,  rather  than  ten  per  cent  or  thirty,  being  depend- 
ent entirely  on  the  judgment  of  Mr.  Darling,  the  Chief 
Engineer).  The  unit  costs,  used  in  connection  with  these 
grading  figures,  were  such  as  Mr.  Darling  thought  would 
be  paid  through  a  period  of  ten  years  supposing  "a  certain 
amount  of  plant  available  for  the  work."  The  prices  were 
"about"  those  that  would  be  paid  the  contractors,  plus 
allowance  for  the  work  which  the  company  would  itself  do 
after  "accepting"  the  grading  done  by  the  contractors.1 
At  the  time  of  his  testimony  in  the  Minnesota  Rate  Cases, 
these  figures  were  over  two  years  old,  and  the  interim  had 
seen  the  panic  of  1907.  There  was  on  this  account,  in  July 
of  1908,  "a temporary  depression  in  prices  below  what 
they  were  in  1906  and  1907."  However,  "if  the  Northern 
Pacific  were  to  start  to  build  its  something  over  8000  miles 
of  track  .  .  .  within  ten  years,"  Mr.  Darling  felt  that  "it 
would  have  an  influence  in  stiffening  prices  back  to  their 
highest  level."  2  It  would  not  be  worth  while,  however,  to 

1  Minnesota  Rate  Cases,  Record  (N.P.),  pages  10-11. 

2  Examination  by  Mr.  How  for  the  company,  ibid.,  page  584.    Mr. 
Darling  also  explained  the  importance  of  supposing  "a  certain  amount" 
of  plant  available:  "  Why  the  price  of  grading,  the  cost  to  us  of  work,  de- 
pends entirely  upon  the  available  plant  of  contractors,  and  on  what  we 
have  ourselves.   When  we  have  a  lot  of  idle  plant,  more  than  enough  to 
keep  the  work  going,  the  price  would  not  go  up.  ...  When  labor  is  plen- 


64  RAILROAD   VALUATION 

continue  through  the  inventory,  item  by  item.  For  present 
purposes,  it  is  the  point  of  view  that  is  significant,  the  un- 
derlying hypothesis.  Though  the  prices  used  were  in  many 
instances  "very  close"  to  those  being  paid  in  June,  1908, 
all  were  chosen  on  the  basis  that  the  work  could  be  done  in 
ten  years. l  The  prices  were  "  future  "  prices,  not  "  present " 
prices,  even  in  1906  when  the  estimate  was  first  made. 

In  his  appraisal  of  the  Minnesota  lines,  especially  pre- 
pared for  the  Minnesota  Rate  Cases,  Mr.  Darling  aban- 
doned all  attempt  at  prophecy,  however,  and  based  his 
figures  upon  "present  prices."  2  By  express  provision  of 
the  statute  directing  the  making  of  the  Nebraska  valuation, 
the  same  basis  was  prescribed  for  the  work  there;  the  bill 
even  providing  for  periodic  "revaluations."  3  The  Wash- 
ington Commission  prided  itself  that,  having  a  full  in- 
ventory of  unit  quantities,  it  could  at  any  time  secure  an- 
other cost  of  reproduction  estimate  by  applying  "present 
prices."  4  And  the  South  Dakota  Commission,  using  in- 

tiful,  the  cost  of  labor  comes  down."  See  page  117,  and  page  2059 
(Mr.  Morgan's  denial). 

The  Valuation  Brief  of  1915  (page  139)  says:  "It  is  the  common  ex- 
perience of  all  railroad  companies  that  prices  of  labor  and  materials  tend 
to  rise  whenever  a  construction  enterprise  of  any  considerable  size  is 
undertaken,  and  it  therefore  follows  that  prices  existing  when  there  is 
stagnation  in  railroad  building  should  be  given  little  if  any  weight 
as  a  guide  to  normal  unit  prices.  It  also  follows  that  the  announcement 
of  an  undertaking,  comparable  to  the  reproduction  of  any  of  the  rail- 
roads of  the  United  States,  would  at  once  tend  to  increase  the  prices  of 
labor  and  materials,  and  the  shorter  the  time  allotted  to  the  reproduction 
programme,  the  more  intense  would  be  the  increase  in  the  prices  of  such 
labor  and  materials.  Prices  of  labor  and  materials  at  a  time  when  there 
is  little  or  no  demand  should,  therefore,  not  be  taken;  and  on  the  other 
hand,  there  should  not  be  assumed  a  demand  in  excess  of  a  supply  rea- 
sonably available  within  the  time  required  for  a  proper  reproduction 
programme." 

1  Minnesota  Rate  Cases,  Record  (N.P.),  page  33;  see  page  37  to  the 
same  effect. 

2  See  Complainant's  Exhibit  3,  N.P.  Case. 

8  Commission  Regulation  (National  Civic  Federation),  pages  196-97. 
4  Second  and  Third  Annual  Reports,  Railroad  Commission  of  Wash- 
ington, page  129.  To  the  same  effect,  see  Report  of  W.  D.  Taylor,  Chief 


PHYSICAL   VALUATION  65 

terchangeably  the  phrases,  "cost  of  reproduction"  and 
"value,"  declared  that,  since  cost  of  reproduction  is 
"changing  constantly  ...  in  order  to  be  of  any  practi- 
cal use,  the  physical  valuation  should  be  continued  from 
year  to  year,  so  that  in  each  year  the  valuation  of  the 
property  will  reflect  the  actual  conditions  during  that 
year."  l 

Average  prices  over  a  period  of  years  immediately  pre- 
ceding the  date  of  the  appraisal,  though  resorted  to  in  part 
by  M.  E.  Cooley  in  the  Michigan  valuation,2  have  received 
their  widest  use  in  the  hands  of  the  Wisconsin  engineers.5 
In  Minnesota  Mr.  Morgan  consoled  the  Commission  over 
the  refusal  of  the  roads  to  accept  a  five-year  average,  with 
the  statement  that  a  review  of  prices  for  the  five  years 
prior  to  June  30,  1907,  the  effective  date  of  his  appraisal, 
showed  that  in  most  respects  the  prices  used  were  as  near 
the  five-year  average  as  was  "practicable"  for  the  purpose 
of  his  inquiry.4  The  figures  used  in  the  appraisal  of  the 
New  Haven  System  made  under  Mr.  Swain's  direction 
were  based  "upon  the  average  ruling  price  for  the  various 
elements  during  the  past  few  years"  —  hardly  a  very 
definite  explanation.5 


Engineer,  Wisconsin,  Bulletin  21,  U.S.  Census,  Commercial  Valuation  of 
Railway  Operating  Property,  page  87. 

1  South  Dakota  R.R.  Appraisal,  Report  of  C.  C.  Witt,  Engineer,  page 
4;  introductory  comment  by  the  Board. 

*  Discussed  at  length  by  H.  E.  Riggs,  Transactions,  Am.  Soc.,  C.E., 
volume  72,  page  13. 

*  The  expedient  of  using  five-year  averages,  first  adopted  by  W.  D. 
Taylor  for  his  Railroad  Appraisal  of  1901,  has  been  used  in  the  subsequent 
public  utility  appraisals.    See,  especially,  State  Journal  Publishing  Co. 
9.  Madison  G.  &  E.  Co.,  4  W.R.C.R.  501;  and  Milwaukee  v.  M.E.R.  & 
L.  Co.,  10  W.R.C.R.  1. 

4  Supplement,  Report,  Railroad  &  Warehouse  Commission  of  Minne- 
sota, 1908,  page  7.  See  his  testimony,  Minnesota  Rate  Cases,  Record 
(N.P.),  page  1780. 

6  The  New  Haven  Validation  Report,  page  88.  "In  some  cases  they 
were  based  upon  the  figures  given  by  the  chief  engineer  of  the  railroad 
company  as  to  the  actual  prices  which  the  company  has  been  paying.". , 


66  RAILROAD   VALUATION 

In  order  to  avoid  using  figures  affected  by  conditions 
of  the  moment  the  Wisconsin  Commission  has  resorted 
to  "average  prices."  The  expressed  desire  has  been  to 
secure  "a  reasonable  middle  ground,  neither  high  nor 
low/' guarding  "against  extreme  fluctuations."  1  Applying 
such  an  average  cost,  to  an  "average"  or  typical  unit  (as, 
for  example,  attempting  to  get  a  unit  price  for  "earth" 
over  the  whole  State)  has  piled  approximation  on  approxi- 
mation. An  average  is  never  more  than  a  rough  measure- 
ment, depending  for  its  value  entirely  upon  the  care  with 
which  the  data  are  chosen,  and  the  accuracy  with  which 
they  are  handled.  That  an  "average"  price  should  be 
worth  more  than  a  price  fixed  only  by  "  expert  opinion  "  is 
very  doubtful.  On  the  grounds  of  statistical  significance, 
a  large  percentage  of  error  must  be  reckoned  with  in  either 
case.  And  why,  if  five  years  is  a  desirable  period  over 
which  to  consider  data,  should  not  the  period  be  extended 
to  six,  or  ten,  or  even  twenty  years?  There  is  always 

1  State  Journal  Publishing  Co.  ».  Madison  G.  &  E.  Co.,  4  W.R.C.R. 
501,  509. 

The  following,  from  the  Wisconsin  Commission's  opinion  in  Hill  v. 
Antigo  Water  Co.,  indicates  the  philosophy  behind  the  "average"  figures 
of  the  Wisconsin  appraisals: 

"  Current  prices  are  the  most  easily  obtained,  and  they  offer  the  fewest 
complications,  but  the  results  obtained  under  them  may  not  always  be 
fair  to  all  concerned.  Average  prices  are  more  difficult  to  secure,  and  they 
also  imply  that  in  selecting  them,  there  must  be  choice  of  periods  or  quo- 
tations, upon  which  choice  many  disputes  may  hang.  To  secure  prices, 
however,  that  approximately  represent  normal  conditions  is  by  no  means 
impossible,  and  it  is  likely  that  such  prices  would,  in  most  cases,  be  the 
fairest  of  all.  .  .  . 

"  Rates  based  upon  valuations  that  rest  on  current  prices  would  neces- 
sarily have  to  be  changed  with  all  changes  in  these  prices.  This  would  man- 
ifestly be  impracticable,  and  perhaps  unjust  both  to  the  plant  and  its 
customers.  Prices  of  practically  every  element  are  moving  up  and  down 
so  often  that  under  no  known  method  could  the  rates  be  changed  and 
applied  with  equal  frequency  .  .  .  desired  stability  in  the  valuation  can 
usually  be  obtained  by  carefully  computing  it  upon  the  average  prices 
for  a  term  of  years.  .  .  .  Just  how  long  a  period  should  be  chosen  cannot 
be  stated  offhand.  But  a  little  investigation  will  readily  disclose  the 
usual  or  normal  -price  in  each  case,"  etc.  3  W.R.C.R.  623,  638-40. 


PHYSICAL   VALUATION  67 

danger,  when  averages  are  used  and  a  large  volume  of 
material  handled,  that  tabulations,  mechanically  ingenious, 
will  be  accepted  as  scientifically  valid.  An  "average" 
cost  is  an  especially  dangerous  tool.  In  a  period  of  rising 
or  falling  prices  and  wages,  the  length  of  the  period  used 
must  of  necessity  materially  affect  the  results  secured. 
For  the  purpose  of  the  Wisconsin  Commission  a  five-year 
"average"  price  may  be  satisfactory.  But  the  appraisal 
figures  secured  have  been  only  approximations,  neither 
more  nor  less  significant  than  if  secured  on  a  "present" 
or  "future"  price  basis. 

The  railroads  have  urged,  in  the  conferences  held  to 
establish  bases  for  determining  unit  prices  for  the  Federal 
Valuation,  that  averages  should  be  "  weighted "  with 
judgment.  Two  sets  of  factors  should  be  considered: 

"Actual  prices  (weighted  average)  and  conditions  affecting 
labor  and  material  markets  during  a  period  of  ten  years  pre- 
ceding June  30,  1914,  with  appropriate  consideration  to  the 
existence  or  non-existence  of  actual  railroad  construction  in 
that  period."  * 

The  programme  would  seem  a  combination  of  the  "aver- 
age" basis  and  the  "future"  basis. 

Indeed,  the  further  assumption  has  been  that  the  In- 
terstate Commerce  Commission  faces  a  problem  "like 
that  of  a  contractor": 

"The  contractor  who  is  about  to  bid  for  the  construction 
of  any  of  these  railroads  .  .  .  would  consider  averages  .  .  . 
trends  .  .  .  present  prices  .  .  .  conditions  of  the  labor  and 
material  markets,  and  many  other  factors;  having  taken  all 

1  The  Valuation  Brief  of  1915,  page  141:  "  The  prices  to  be  used  in  the 
valuation  should  be  arrived  at  by  a  consideration  of  prevailing  prices, 
price  tendencies  and  conditions  and  material  markets  during  a  reason- 
able period  of  time  next  preceding,  and  at  the  date  as  of  which  the 
valuation  is  to  be  made,  due  consideration  being  given  the  existence 
or  non-existence  of  active  railroad  construction  during  that  period" 
(page  134). 


RAILROAD  VALUATION 

into  consideration  he  would  arrive  at  a  conclusion  infinitely 
more  accurate  than  any  mere  automatic  or  mechanical  deter- 
mination. The  average  which  he  would  consider,  and  which 
we  urge  should  be  considered,  is  the  '  weighted  average.'  .  .  . 
If  the  contractor  finds  that  the  trejnd  is  level,  he  comes  out 
pretty  safely  in  taking  prices  which  will  approximate  .  .  . 
the  weighted  average.  If  he  finds  the  trend  is  definitely  up- 
ward, he  will  not  care  so  much  about  an  average  of  prices 
made  years  ago,  below  the  lowest  of  the  present,  but  will 
consider  almost  exclusively  present  prices,  disregarding  the 
unusual  and  the  bulges  caused  by  periods  of  great  boom, 
and  the  drops  caused  by  temporary  flurries  and  panics.  So, 
if  he  finds  the  trend  is  definitely  downward,  he  will  not  pay 
much  attention  to  a  high  average,  or  high  past  prices  when 
all  the  recent  prices  have  been  low.'* l 

"The  particular  prices  to  be  employed  for  a  particular 
carrier  will  vary  from  average  prices  as  conditions  require. 
After  all  phases  and  conditions  surrounding  the  work  have 
been  digested,  a  decision  must  be  reached  by  the  exercise 
of  sound  judgment,  and  frank  discussions  between  repre- 
sentatives of  the  Government  and  the  carriers."  2 


Especially  intricate  would  be  the  task  of  fixing  a  unit 
price  for  a  commodity  no  longer  on  the  market  in  signif- 
icant quantities.  Departure  from  the  use  of  ten-year 
averages,  and  the  use  of  "price  tendencies  for  an  appro- 
priate period,"  has  here  been  suggested  by  the  railroads.3 
An  example  will  readily  serve  to  illustrate  the  difficulty. 
Oak  ties,  comprising  over  an  eighth  of  the  ties  in  the 
Minnesota  lines  of  the  Great  Northern,  had  originally  been 
cut  along  the  right  of  way  by  the  farmers.  But  in  1909, 
the  supply  of  oak  ties  in  that  State  was  practically  ex- 
hausted; and,  if  oak  ties  were  to  be  "reproduced,"  it 
would  be  necessary  to  draw  on  Southern  forests.  Accord- 
ingly the  Great  Northern  Engineer,  A.  H.  Hogeland, 
used  the  unit  price  of  85  cents  a  tie,  a  price  which  J.  F. 

1  Valuation  Conference  of  September  30,  1915,  statement  of  Sanford 
Robinson,  of  counsel  for  the  railroads,  Proceedings,  pages  31-33. 
3  The  Valuation  Brief  of  1915,  page  128.  *  Ibid.,  page  142. 


PHYSICAL  VALUATION  69 

Stevens,  who  "had  a  pretty  intimate  knowledge  of  the  oak 
tie  situation  throughout  Missouri  and  Arkansas  and 
Indian  Territory,"  agreed  would  be  the  cost  of  oak  ties 
bought  in  St.  Louis,  and  delivered  in  Minnesota.  As  a 
matter  of  fact  no  such  price  was  being  paid;  and,  as  might 
be  expected,  oak  ties  were  not  being  used  by  the  Great 
Northern.  Any  advantages  which  such  ties  might  possess, 
and  these  advantages  were  set  forth  in  detail  by  Mr. 
Stevens,  were  compensated  by  the  lower  prices  for  cedar  and 
other  ties.1  Instead  of  determining  a  "reasonable"  unit 
price  for  oak  ties  on  the  Great  Northern,  the  Master 
avoided  this  difficulty  by  applying  the  unit  prices  testified 
to  by  Mr.  Darling  of  the  Northern  Pacific.  But  he  did  not 
take  Mr.  Darling's  price  for  oak  ties  of  75  cents  and 
transfer  it  to  the  case  of  the  Great  Northern.  Instead  he 
took  the  average  "cost  of  reproducing"  ties,  a  weighted 
average  of  67.2  cents  per  tie,  and  applied  it  to  the  num- 
ber of  ties  estimated  to  be  in  the  Great  Northern  line, 
with  an  entirely  different  distribution  as  between  oak, 
cedar,  tamarack,  etc.  The  price  of  55.5  cents  which  had 
been  applied  in  the  State  appraisal  to  all  ties,  and  to  all 
roads  alike,  was  rejected  on  two  grounds:  "the  rapidly  in- 
creasing price  of  ties,"  and  the  failure  to  allow  for  inspec- 
tion and  handling.2  This  illustration  of  the  determination 
of  "unit  costs"  for  ties  thus  serves  to  emphasize  three 
difficulties  involved  in  choosing  "unit  costs":  (1)  lack  of 
data  for  certain  items  of  the  inventory;  (£)  the  tempta- 

1  A.  H.  Hogeland,  Minnesota  Rate  Cases,  Record  (G.N.),  pages 
101-02;  J.  F.  Stevens,   ibid.,  pages  431-36;  D.  C.  Morgan,  Record 
(N.P.),  page  1930.    See  also  G.  F.  Swain,  the  New  Haven  Validation  Re- 
port, page  80:  "Additional  ties  would  ...  be  procured  from  other  parts 
of  the  country,  at  higher  prices  [than  those  paid  for  ties  cut  along  the 
right  of  way],  so  this  item  might  easily  be  increased  by  a  million  dollars 
or  more." 

2  Report  of  Chas.  E.  Otis,  page  226.  The  Brief  for  the  Companies, 
page  305,  complained  that  this  expedient  unduly  reduced  the  present 
cost  of  Great  Northern  ties  as  established  by  its  current  expendi- 
tures. 


70  RAILROAD  VALUATION 

tion  to  secure  an  "average"  or  "bulk"  figure;  (3)  the 
dependence  upon  experts.1 

These  difficulties  are  closely  related.  The  lack  of  data 
necessarily  means  reliance  upon  experts;  and  the  fact  that 
experts  do  not  agree  serves  to  emphasize  the  dependence 
upon  "judgment"  —  though  if  the  experts  did  agree  it 
would  not  furnish  any  conclusive  proof  one  way  or  the 
other.  Then  the  use  of  an  idealized  unit  of  cost,  an 
"average"  tie,  an  "average"  mile  of  track,  an  "aver- 
age" yard  of  earth,  an  "average"  water  station,  etc., 
indicates  resort  to  a  short  cut  which  at  once  shuts  off 
the  possibility  of  securing  more  than  the  most  uncertain 
approximation.2  The  Master's  use  of  such  an  "average" 
for  ties  was  simply  adoption  of  an  expedient  used  by  all 
the  engineers  testifying  before  him.  In  South  Dakota, 

1  Operating  in  the  same  general  territory,  it  might  be  expected  that 
the  Northern  Pacific  and  Great  Northern  figures  of  cost  would  be  very 
close  together.    While  undoubtedly  standards  might  not  be  the  same  in 
both  cases,  yet  it  might  well  be  expected  that  for  rails,  ties,  grading, 
lumber,  labor,  etc.,  the  unit  prices  would  be  approximately  the  same.  As 
a  matter  of  fact,  the  prices  varied  considerably,  now  the  N.P.  price  being 
the  greater,  now  the  G.N.     Sometimes  the  Master  applied  the  G.N. 
price  to  the  N.P.  quantities  and  sometimes,  as  in  the  case  of  ties,  an  aver- 
age N.P.  price  to  G.N.  quantities.  For  example,  the  G.N.  ballast  price  of 
62  cents  was  used  for  the  N.P.  which  had  claimed  a  price  of  66  cents, 
though  an  aggregate  of  1,548,332  cubic  yards  of  ballasting  had  been  done 
in  the  years  1906,  1907,  and  1908  at  an  average  cost  of  81.69  cents  per 
cubic  yard.   See  Minnesota  Rate  Cases,  Record  (N.P.),  page  3221,  and 
Brief  for  the  Companies,  page  286  and  following. 

2  The  appraisal  of  the  Northern  Pacific  made  by  J.  B.  Berry,  Chief 
Engineer  of  the  Rock  Island,  and  presented  to  the  Interstate  Commerce 
Commission,  was  based  upon  a  series  of  "  unit  miles,"  designated  A,  B, 
C,  D,  etc.  As  Mr.  Berry's  train  passed  over  a  mile  of  track,  he  "  simply 
looked"  from  a  post  of  vantage  in  his  private  car,  and  made  note  as  to 
whether  it  belonged  in  A,  B,  C,  or  whether  he  should  not  take  one  half  of 
each  of  the  costs  for  grade  A  and  B  —  i.e.,  AB,  etc.  His  car  was  attached 
to  regular  trains,  he  completed  his  examination  of  about  one  half  of  the 
system  in  approximately  three  weeks,  covering  about  250  miles  per  day, 
and  classified  some  of  the  unimportant  branches  without  this  inspection. 
But  his  figure  was  duly  presented  to  the  Commission  as  "  expert "  testi- 
mony.   He  estimated  the  cost  of  reproducing  the  Northern  Pacific  as 
$395,376,749.40(1).  Minnesota  Rate  Cases,  Record  (N.P.),  page  718  and 
following;  and  Complainant's  Exhibit  25. 


PHYSICAL  VALUATION  71 

the  Commission's  Chief  Engineer  even  found  such  an 
"average"  for  all  land  in  the  State.1  Mr.  Taylor,  in 
Wisconsin,  was  "anxious"  to  secure  the  agreement  of  the 
various  engineers  that  20  cents  a  cubic  yard  for  earth- 
work excavation  without  overhaul  was  a  reasonable  price 
all  over  the  State.2  Mr.  Hogeland,  of  the  Great  Northern, 
used  a  classification  of  grading  quantities  that  included 
seven  distinct  categories;  Mr.  Darling  "bunched"  all 
grades  except  solid  rock,  thus  simplifying  his  arithmetical 
task.3  Similarly,  in  the  Spokane  Case  "valuation,"  he  had 
fixed  upon  a  price  for  "an  average  water  station,"  for 
roundhouse  stalls,  for  fencing  (using  a  figure  of  $150  per 
mile,  though  the  price,  due  to  different  specifications, 
varied  from  $130  to  $300  per  mile).  "Clearing"  he  put  in 
at  $80  per  acre,  though  the  prices  varied  "all  the  way  from 
$35  to  $250  an  acre."  Even  the  tunnels  were  grouped,  and 
"average  costs"  used.4  Just  as  interesting  was  the 
Minnesota  appraisal  of  locomotives,  by  the  pound.  Mr. 
Morgan  had  "never  bought  any  locomotives,"  but  he 
was  able  to  say  that  none  of  the  locomotive  company 
representatives  with  whom  he  talked  seemed  'to  be  em- 
barrassed in  the  slightest  when  he  talked  to  them  of  the 
cost  of  locomotives  by  the  pound.  They  had  in  their 

1  "  The  average  value  of  the  State  worked  out  $32  an  acre  approxi- 
mately. Taking  the  acreage  of  16,138.6,  multiplying  that  by  $32,  and  by 
the  multiple  2£,  gives  a  value  of  $1,292,483."    Testimony  of  C.  C.  Witt, 
quoted,  C.  &  N.W.  Ry.  t>.  Smith,  210  Fed.  632,  639. 

2  Report  of  W.  D.  Taylor,  Bulletin  21,  Bureau  of  the  Census,  Com- 
mercial Valuation  of  Railway  Operating  Property,  page  86. 

3  Mr.  Hogeland  listed  earthwork  under  four  headings:  18  cents  a 
cubic  yard;  23  cents;  31  cents;  39  cents;  in  addition  he  had  the  classi- 
fications: hard  pan,  45  cents;  loose  rock,  55  cents;  solid  rock,  $1.25.  Mr. 
Darling,  however,  used  only  the  figures  for  solid  rock,  $1.25,  and  "  earth," 
including  everything  except  solid  rock,  33  cents.    In  the  Spokane  Case, 
he  had  made  use  of  four  classes:  earth,  28  cents;  hard  pan,  42  cents; 
loose  rock,  50  cents;   solid  rock,  $1.10.    In  all  cases  these  figures  were 
intended  to  include  work  done  by  the  company,  as  well  as  the  amounts 
paid  the  contractors.  See  testimony  of  A.  H.  Hogeland,  Minnesota  Rate 
Cases,  Record  (G.N.),  page  13;  of  W.  L.  Darling,  ibid.  (N.P.),  page  3212. 

4  Minnesota  Rate  Cases,  Record  (N.P.),  pages  41, 42, 68, 69. 


72  RAILROAD  VALUATION 

pockets  all  of  the  data  on  the  pound  basis.  So  that  he  had 
a  right  to  assume  that  as  an  intelligent  basis  upon  which 
to  consider  locomotives,  because  locomotives  vary  in 
weight.  .  .  .  He  did  not  know  of  a  more  convenient  unit 
to  apply  than  that.' l  In  short,  Mr.  Morgan  adopted  the 
rule-of -thumb  measure  (a  figure  used  by  railroad  men  to 
gauge,  very  roughly,  relative  costs,  as  new  and  bigger 
engines  are  built)  as  the  basis  of  an  estimate  of  the  "cost  of 
reproducing"  locomotives.  This,  in  the  case  of  the  North- 
ern Pacific,  he  reported  to  the  Commission  as  $3,230,790.51, 
etc.  And,  it  must  be  remembered,  the  distinguishing 
feature  of  his  appraisal  was  its  "thoroughness." 

The  figures  for  all  "cost  of  reproduction"  estimates, 
though  immediately  depending  upon  the  expert  opinion  of 
engineers,  have,  of  course,  been  based  to  a  greater  or  less 
degree  on  prices  paid  by  the  railroads.  Even  Mr.  Darling's 
attempt  at  a  prophecy  over  a  period  of  ten  years  used 
prices  which  approximated  those  currently  paid.  But  there 
is  a  difficulty  even  in  the  use  of  present  prices  which  forces 
resort  to  approximation :  this  is  the  fact  that  similarity  of 
problem  does  not  exist  upon  all  lines  of  railroad.  Were  all 
other  things  equal,  a  "present  price"  appraisal  might  take 
prices  paid  currently  in  one  section  of  the  country  or  upon 
one  road,  even  upon  one  branch  of  the  same  road.  But 
the  fact  remains  that  all  other  things  are  not  equal,  that 
rates  of  wages  vary  over  the  country,  that  construction 
materials  (lumber,  concrete,  steel)  likewise  vary,  that 
different  construction  problems  are  presented.  Moreover, 
prices  do  not  remain  stable  throughout  a  year.  There  is 
necessarily  difficulty  in  picking  out  figures  not  vitiated 
by  some  peculiar  set  of  circumstances.  A  general  approxi- 
mation may,  perhaps,  be  made,  but  that  is  all. 

1  Minnesota  Rate  Cases,  Record  (N.P.),  pages  1781-82.  See  Report 
of  W.  S.  Thorington,  Special  Master,  Central  of  Georgia  Case,  page 
138,  where  "pound"  prices  were  also  applied  to  cars  (page  139).  Mr. 
Morgan  took  the  car  as  the  unit,  however. 


PHYSICAL  VALUATION  73 

in 

Conceivably  allowance  might  be  made  for  the  "over- 
head" charges  by  including  cost  of  engineering,  promo- 
tion, etc.,  in  the  unit  prices.  In  practice  there  has  been  no 
resort  to  this  expedient.  Freight  charges,  fixed  for  "aver- 
age" distances,  have  sometimes  been  so  included,  though 
practice  here  has  not  been  uniform.1  Cost  of  handling 
rails  and  other  materials  has  likewise  been  swallowed  up 
in  the  unit  price.2  But  for  the  items  covering  cost  of  gen- 
eral supervision,  financial  and  legal  as  well  as  technical, 
practice  has  resorted  to  the  use  of  "average"  percentages, 
applied  to  all  roads  alike,  as  was  the  "contingencies"  al- 
lowance.3 In  these  instances,  too,  some  variation  has  ap- 
peared in  the  case  of  different  appraisals,  as  to  the  items 
which  should  be  included  in  the  totals.    But  the  policy 
has  in  general  been  to  determine  the  allowance  for  engi- 
neering and  legal  expenses  by  multiplying  the  "cost  of  re- 
producing" the  permanent  way  and  structures  (including 
land)  by  the  percentage  chosen ;  and  that  for  organization 
through  using  the  entire  total.   These  expedients,  first  used 
by  M.  E.  Cooley  in  the  Michigan  appraisal,  therefore  rep- 
resent the  approved  "valuation"  practice.4 

1  In  figures  presented  in  the  Minnesota  Rate  Cases,  Mr.  Darling,  of 
the  Northern  Pacific,  included  the  cost  of  freight,  roughly  estimated, 
in  his  "unit  prices."   Record  (N.P.),  pages  945-52  and  3219-20.  Mr. 
Hogeland,  of  the  Great  Northern,  introduced  a  separate  item  for  "Freight 
on  Construction."  Record  (G.N.),  pages  48-51 .  Mr.  Morgan  followed  the 
latter  practice,  using  a  lower  basis  for  his  calculation  than  either  Mr. 
Darling,  or  Mr.  Hogeland,  Record  (N.P.),  pages  1942,  1950;  (G.N.), 
pages  1381, 1464;  see  testimony  of  J.  F.  Stevens,  Record  (G.N.),  page  459. 

2  The  Minnesota  Rate  Cases,  Brief  for  the  Companies,  pages  305,  307. 

8  An  exception  to  this  rule  was  the  "valuation"  of  the  Northern  Pa- 
cific made  by  Mr.  Berry,  of  the  Rock  Island,  using  the  "unit  mile"  sys- 
tem of  appraisal  (see  note  2,  page  70,  above).  He  estimated  "legal  ex- 
penses" at  $50  per  mile,  "general  expenses"  at  $100  per  mile,  etc.  For 
"engineering,"  however,  he  used  the  percentage  method.  Minnesota 
Rate  Cases,  Record  (N.P.),  Complainant's  Exhibit  26  —  Berry. 

4  See  Senate  Report  on  Valuation,  pages  172-74,  where  the  allowances 
for  "overhead"  charges  are  given  in  detail. 


74  RAILROAD  VALUATION 

Though  the  method  of  calculation  has  been  essentially 
the  same  for  all  appraisals,  the  percentages  used  have 
varied  according  to  the  personal  opinion  of  the  engineer 
making  the  appraisal.  This  would  be  the  normal  expecta- 
tion when  it  is  recognized  that  the  percentage  allowance 
is  only  an  "average"  figure.  But  in  each  of  the  State 
appraisals,  the  same  percentage  has  been  applied  generally 
to  all  roads.  Mr.  Morgan's  charge  for  engineering  and 
superintendence  was  four  per  cent.1  This  figure  he  used  for 
all  roads  in  the  State:  main  lines  and  branch  lines;  roads  of 
high  physical  standards,  and  those  of  low;  terminal  com- 
panies as  well  as  the  transcontinental.  There  was  no 
attempt  to  differentiate  between  the  Great  Northern,  with 
over  two  thousand  miles  of  main  track,  and  the  Mason 
City  and  Fort  Dodge  with  twenty-seven,  or  between  these 
and  the  Minnesota  Transfer  Railroad,  etc.2  Nor  has 
there  been  attempt  at  intelligent  discrimination  in  any 
of  the  other  State  "valuations."  The  percentages 
have  been  adopted  to  cover  engineering,  legal  expenses, 
organization,  and  applied  to  all  cases  quite  automati- 
cally. Detailed  consideration,  therefore,  need  not  hold 
us  here. 

It  is  worth  while,  however,  to  pause  for  the  moment  to 
show  the  method  by  which  the  percentages  adopted  have 
been  chosen.  To  the  uninitiated  it  might  appear  that  the 
figures  chosen  were  "expert"  guesses.  If  we  are  to  accept 
the  assurance  of  the  engineer  who  made  the  South  Dakota 
appraisal,  Mr.  C.  C.  Witt  (later  on  the  staff  of  the  Inter- 
state Commerce  Commission),  the  contrary  is  true:  "Ex- 
tensive research  has  demonstrated  that  the  cost  of  this 
item  [engineering]  ...  is  equivalent  to  four  per  cent  of 

1  On  all  items  exclusive  of  equipment,  legal  expense,  freight  on  con- 
struction material,  stores  and  supplies,  contingencies,  and  interest  during 
construction,  Senate  Report  on  Valuation,  page  172.  See  Supplement,  Re- 
port, Railroad  &  Warehouse  Commission  of  Minnesota,  1908,  page  71. 

2  These  instances,  simply  taken  at  random  from  his  report,  are  found 
at  pages  82,  83,  84,  ibid. 


PHYSICAL  VALUATION  75 

the  roadway  and  right  of  way."  1  This,  as  a  matter  of  fact, 
has  been  the  percentage  used  in  Minnesota,  Michigan, 
South  Dakota,  Nebraska,  and  Wisconsin.  In  Wisconsin 
and  Minnesota  the  allowance  for  engineering  was  com- 
bined with  that  for  legal  expense,  one  half  per  cent  —  a 
total  of  four  and  one  half  per  cent.2  The  adequacy  of  the 
"research"  seems  doubtful,  if  the  method  by  which  the 
percentage  allowance  for  engineering  and  legal  expenses 
was  chosen  in  Minnesota  can  be  taken  as  at  all  typical. 
It  is  Mr.  Morgan  testifying : 

"Q.  Will  you  explain  how  you  arrived  at  the  proper 
percentage  used  .  .  .  four  and  one  half  per  cent? 

"  A.  There  are  some  of  these  things  that  have  been  done 
deductively.  Probably  no  one  can  estimate  with  mathe- 
matical exactness  what  the  percentages  should  be,  but  in 
order  to  arrive  at  this  in  an  intelligent  way,  I  listed  the 
percentages  on  this  item  that  had  been  turned  in  by  the  va- 
rious railway  companies  that  had  submitted  reports  for  this 
appraisal.  I  found  one  railroad  that  showed  .88  of  one  per 
cent;  one  railroad  ...  1.3  per  cent;  eleven  railroads,  4J  per 
cent;  four  ...  5  per  cent;  one  .  .  .  5i  per  cent;  one  .  .  .  5.7 
per  cent;  one  ...  6  per  cent;  four  ...  10  per  cent;  and  two 
...  15  per  cent.  The  consensus  of  opinion  seemed  to  show 
that  4$  per  cent  for  engineering,  superintendence  and  legal 
expenses  was  a  fair  rate  to  apply,  and  for  that  reason  we 
adopted  that  rate." 3 


1  First  Report,  Public  Utilities  Commission  of  Kansas,  page  29.    Mr. 
Witt  had  begun  an  appraisal  in  Kansas  when  the  work  of  the  Federal  Valu- 
ation halted  his  activities.     A  "cost  of  reproduction"  estimate  of  the 
Union  Pacific  was  completed.  Ibid.,  page  33. 

2  Again  there  has  been  some  variation  in  the  basis  for  calculation. 
See  Senate  Report  on  Valuation,  pages  172-74. 

9  Minnesota  Rate  Cases,  Record  (N.P.),  pages  1851,  2032,  2037. 

"Research"  of  the  same  general  character  was  outlined  in  the  testi- 
mony of  W.  L.  Darling,  ibid.,  pages  13  and  3239;  and  of  J.  B.  Berry,  of 
the  Rock  Island,  ibid.,  page  744;  of  A.  H.  Hogeland,  Record  (G.N.), 
page  52.  See  remarks  of  G.  F.  Swain  (the  New  Haven  Validation  Report, 
page  85),  and  especially  his  comparative  table  (page  123),  where  four 
sets  of  "overhead"  charges  are  listed  on  the  same  property  varying  (in 
total)  from  16  per  cent  to  33  per  cent. 


76  RAILROAD  VALUATION 

Testimony  of  this  character  indicates  an  entire  absence 
of  "research."  The  figure  chosen  was  a  guess,  necessarily 
an  "average"  figure,  intended  to  apply  indiscriminately. 
In  any  case  only  an  estimate  could  be  made;  and,  by  and 
large,  four  and  a  half  per  cent  was  perhaps  just  as  near 
the  truth  as  would  have  been  seven  per  cent,  or  three. 
For  the  present  purpose  it  is  enough  to  indicate  that  any 
accuracy  claimed  for  an  estimate  of  "valuation"  which  in- 
cludes such  percentage  allowances  is  specious.1  Without 
pausing  to  consider  in  detail  promotion,  organization  ex- 
penses (the  so-called  "general  expenses"),  it  is  possible, 
therefore,  to  turn  to  the  item  of  "interest  during  con- 
struction." 

Any  allowance  for  interest  is  a  function  of  two  variables, 
a  rate  and  a  period  of  time.  The  rate  used  has  been  the 
usual  guess  of  the  engineer,  who,  it  might  seem,  would 
be  more  at  home  in  fixing  upon  unit  prices  for  construction 
quantities  than  in  attempting  solution  of  so  difficult  a 
statistical  task  as  determining  a  "normal"  interest  rate. 
Be  that  as  it  may,  four  per  cent  was  used  in  Minnesota, 
three  per  cent  in  Michigan  and  Wisconsin,  six  per  cent  in 
Nebraska  and  South  Dakota,  five  per  cent  in  Washington.2 
G.  F.  Swain,  in  the  New  Haven  appraisal,  used  six  per 
cent,  "a  rate  a  new  company  intending  to  build  a  road 
would  have  to  estimate  upon." 3  In  discussion  of  the  sub- 
ject by  railroad  men  an  allowance  of  a  "fair  and  reasonable 
return"  on  the  investment  has  been  suggested.4 

1  The  New  York  Public  Service  Commission,  First  District,  has  broken 
away  from  the  percentage  method  of  fixing  the  "cost  of  reproducing" 
overhead  costs,  using  a  lump  sum  allowance  instead.    For  a  discussion 
of  this  attitude  in  detail,  see  "Valuation  Decisions  of  the  New  York 
Public  Service  Commission,  First  District,"  by  R.  H.  Whitten,  Proceed- 
ings, National  Association  of  Railway  Commissioners,  25th  Annual 
Meeting,  page  400. 

2  Senate  Report  on  Valuation,  page  171. 

*  The  New  Haven  Validation  Report,  page  88. 

4  By  W.  H.  Williams  of  the  Delaware  &  Hudson,  Railway  Age  Gazette, 
volume  46,  page  762.  Another  writer  (anonymous)  in  the  same  periodi- 


PHYSICAL  VALUATION  77 

Once  a  rate  has  been  fixed  upon,  no  attempt  to  vary  that 
rate,  as  between  different  roads,  has  been  made  by  the  State 
engineers.  Like  the  percentage  allowance  for  "overhead" 
charges,  the  same  rate  has  been  regularly  applied  to  all  of 
the  lines  appraised.  The  period  of  time  has  usually  been 
made  to  vary;  but  not  always.  In  Michigan  and  Wisconsin 
the  allowance  of  three  per  cent  was  blanketed  to  cover  all 
roads,  without  regard  to  any  hypothetical  construction 
period.  In  Minnesota,  South  Dakota,  Nebraska,  and 
Washington,  the  construction  period  was  made  to  vary, 
though  a  most  curious  underlying  assumption  was  made. 

It  has  generally  been  assumed  that  "on  the  average" 
the  rate  of  interest  (itself  an  arbitrary  rate)  l  should  be 
charged  against  the  total  cost  of  reproduction  for  hah*  of 
the  construction  period.  In  Minnesota,  having  assumed  a 
construction  period  of  four  years,  Mr.  Morgan  added  eight 
per  cent  to  his  cost  of  reproducing  the  Northern  Pacific, 
four  per  cent  to  that  of  the  Burlington,  the  Rock  Island, 
Chicago  Great  Western,  etc.  His  "  idea  was  that  it  would 
not  be  necessary  to  borrow  all  of  the  money  or  to  raise  all 
of  the  money  at  once,  but  it  would  be  raised  in  such  a  way 
that  it  would  be  all  in  use  for  practically  half  of  the  time 
required  to  construct  the  line."  2  Mr.  Morgan  assumed 
that  his  roads  would  be  constructed  all  at  once,  and  that  no 
one  portion  would  be  placed  in  operation  before  any  other 
portion,  an  assumption  in  which  he  was  followed  by  the 
railroad  witnesses.3  In  South  Dakota,  each  line  was 
divided  into  sections  of  one  hundred  miles,  which,  by  the 

cal  suggested  ten  per  cent,  a  rate  "corresponding  to  the  reasonable  re- 
turn which  the  carrier  is  entitled  in  law  to  realize."  Railway  Age  Gazette, 
volume  46,  page  221.  See  also  the  Valuation  Brief  of  1915,  pages  108-114. 

1  D.  C.  Morgan,  Minnesota  Rate  Cases,  Record  (N.P.),  pages  2048 
and  2049.  See  his  report,  Supplement,  Report,  Railroad  &  Warehouse 
Commission  of  Minnesota,  1908,  page  28.  W.  L.  Darling,Record  (N.  P.), 
page  577,  described  his  allowance  as  "  simply  arbitrary." 

8  Ibid.,  page  2050.  See  pages  1855-59. 

*  W.  L.  Darling,  ibid.,  pages  13,  3239;  A.  H.  Hogeland,  Record  (G.N.), 
pages  52  and  161. 


78  RAILROAD  VALUATION 

hypothesis,  could  each  be  reproduced  in  one  year.  Accord- 
ingly interest  was  figured  for  one  half  year  at  six  per  cent.1 
In  Nebraska,  however,  a  "working  section"  of  only  sixty- 
five  miles  was  chosen  as  the  unit,  and  the  interest  charge 
of  six  per  cent  allowed  for  one  and  a  half  years,  a  construc- 
tion period  of  three  years  being  assumed,  etc.2  To  cite 
further  illustrations  of  the  entirely  arbitrary  practice  in 
this  respect  would  only  serve  to  encumber  an  argument 
already  conclusive.  The  allowance  for  interest  has  been 
determined  by  use  of  the  expedient  now  so  familiar  — 
resort  to  an  "average,"  an  assumed  normal,  or  "fair,"  or 
representative  figure. 

IV 

In  the  Minnesota  Rate  Cases,  the  Master  and  Judge 
Sanborn  failed  to  make  deduction  for  accrued  depreciation, 
though  they  had  before  them  the  decision  of  Justice  Moody 
in  the  Knoxville  Case,  insisting  that  such  failure  "would 
lead  to  obviously  incorrect  results."  3  When  the  case 
came  to  Justice  Hughes,  he  simply  relied  upon  the  earlier 
conclusion  of  the  Court  without  supplementing  this  with 
his  own  reasoning.  "When  particular  physical  items  are 
estimated  as  worth  so  much  new,  if  in  fact  they  are  depre- 
ciated, this  amount  should  be  found  and  allowed  for.  If 
this  is  not  done  the  physical  valuation  is  manifestly  incom- 
plete." 4  But  how  the  amount  to  be  deducted  should  be 
determined,  Justice  Hughes  nowhere  intimated. 

The  process  of  calculating  the  amount  of  the  accrued  de- 
preciation is  much  complicated  by  the  fact  that  obsoles- 
cence is  so  important  a  consideration  in  railroad  operations. 

1  South  Dakota  Railway  Appraisal,  Summary  (1910). 

2  Fourth  Annual  Report,  Nebraska  Railway  Commission,  page  450 
and  following. 

8  Knoxville  ».  Knoxville  Water  Co.,  212  U.S.  1,  9. 
*  Minnesota  Rate  Cases,  230  U.S.  352,  458. 


PHYSICAL  VALUATION  79 

"Progress  of  the  arts"  has  quickened  the  force  of  the  in- 
evitable physical  wasting.  "The  whole  conduct  of  the 
business  has  changed  so  that  many  cars  are  put  out  of  use, 
not  because  they  are  worn  out,  but  because  they  become 
unprofitable  or  antiquated  in  form.  Powerful  engines  are 
required;  the  old  draft-rigger  wouldn't  hold  a  train  to- 
gether." 1  Change  in  the  weight  of  trains  and  cars  has 
meant  the  rebuilding  of  bridges,  the  use  of  heavier  rails,  the 
enlargement  of  side  tracks.  Not  infrequently  considerable 
portions  of  the  road  bed  have  been  abandoned,  in  grade 
revision,  and  curvature  elimination.  The  passenger  station, 
fully  adequate  to  serve  the  business  of  twenty  years  ago, 
has  become  inadequate,  "out  of  date,"  and  replacement 
has  been  made.  The  experienced  railroad  man  can  cite 
examples  of  "obsolescence"  almost  without  end.2 

The  effect  of  obsolescence  upon  the  task  of  appraising 
accrued  depreciation  is  twofold.  In  the  first  place,  the  data 
upon  which  to  base  calculations  for  the  future  are  rendered 
slender.  To  what  extent  does  treating  ties  extend  their  life? 
Can  experience  with  a  Prairie  type  locomotive  be  taken  as 
indicating  the  length  of  life  of  a  modern  Mallet  Com- 
pound? There  is  substantially  no  information  upon  which 
to  gauge  the  probable  working  period  of  the  new  steel 
passenger  or  freight  equipment.  Experience  with  wooden 
cars  indicates  nothing  conclusive  about  the  newer  produc- 
tions. What  is  the  effect  upon  rails  of  the  use  of  this 
heavier  equipment?  The  railroad  business  is  essentially 
in  a  "dynamic"  state.  This  weakens  the  possibility  of 
securing  really  reliable  data  upon  which  to  base  estimates 
of  depreciation. 

In  the  second  place,  what  of  the  future?  If  change  has 
come  in  the  past,  must  not  change  be  expected  in  the 

1  J.  J.  Hill.  Minnesota  Rate  Cases,  Record  (G.N.),  page  1301.  See 
testimony  of  E.  P.  Ripley,  Evidence,  1910  Advances,  page  24;  and  that 
of  Daniel  Willard,  ibid.,  page  2360. 

*  Howard  Elliott,  Minnesota  Rate  Cases,  Record  (N.P.),  pages  1251-53. 


80  RAILROAD  VALUATION 

future?  Who  is  to  say  how  much  longer  a  given  station 
building  will  remain  adequate  for  the  use  of  patrons,  how- 
ever much  the  presence  of  an  old  building  may  gall  local 
pride?  Can  it  be  assumed  that  no  heavier  locomotives  are 
to  be  built;  that  still  stronger  bridges  may  not  be  needed? 
That  realignments  are  to  stop,  that  no  new  tunnels  will  be 
built,  or  old  ones  abandoned?  Before  an  "expert"  can 
judge,  however  gross  be  the  approximation,  the  proportion 
of  the  original  investment  used  up,  he  must  know  (or  guess) 
the  probable  total  length  of  life  of  the  "physical  asset" 
being  appraised,  as  well  as  its  present  age.1  Will  electricity 
be  used  more  widely  for  motive  power,  displacing  steam? 
Or  if  steam  persists  in  use,  will  larger  engines  be  built,  or 
will  there  be  a  swing  back  to  smaller  types?  Will  the 
Grand  Central  Terminal  in  New  York  last  fifty  or  a 
hundred  years,  or  a  thousand? 

One  of  two  possible  expedients  (or  a  use  of  both  com- 
bined) has  been  the  general  plan.  Inspection  has  been  de- 
pended upon,  subject  to  all  the  vagaries  of  expert  judg- 
ment; or,  life  tables,  based  on  "averages,"  have  been 
applied,  where  sufficient  data  have  existed  to  afford  a  basis 
of  calculation,  however  uncertain.  In  either  case  the  limita- 
tions governing  the  final  figures  are  significant.  Where  in- 
spection is  depended  upon,  a  tendency  to  minimize  the 
amount  of  the  deduction  can  be  expected.2  And  when  en- 

1  In  the  New  York  Gas  Case,  the  witness  for  the  Public  Service  Com- 
mission testified  that  his  estimate  of  the  depreciation  was  based  on  an 
assumed  life  for  the  plant  that  included  allowance  for  probable  future 
changes  in  the  arts.  The  Master  declined  to  approve  a  mere  "  theoretical 
deficiency."  Accordingly  he  included  plant  that,  it  was  alleged,  was  to  be 
scrapped  in  the  near  future,  "  valued  "  on  the  basis  of  a  detailed  examina- 
tion.  Report  of  A.  H.  Masten,  Special  Master,  page  175.  Willcox  v.  Con- 
solidated Gas  Co.,  212  U.S.  19.  Portions  of  the  line,  included  in  the  Min- 
nesota valuations  at  undepreciated  "cost  of  reproduction,"  were  soon 
to  be  abandoned.  Testimony  of  W.  L.  Darling,  Minnesota  Rate  Cases, 
Record  (N.P.),  page  559.   See  the  Valuation  Brief  of  1915,  page  211. 

2  See  Report  of  the  St.  Louis  Public  Service  Commission  on  Rates  for 
Electric  Light  and  Power,  page  59.    "  In  depreciating,  to  arrive  at  the 
present  value  of  the  depreciable  property,  the  Commission  does  not  con- 


PHYSICAL   VALUATION  81 

tire  dependence  is  placed  upon  "  average  "  figures,  the  special 
conditions  governing  the  individual  plant  (weather,  volume 
of  business,  care  in  maintenance,  etc.)  are  automatically 
thrown  aside.  But  to  contrast  a  deduction  "based  upon 
certainly  ascertained  inspection  or  investigation,"  with 
one  based  "upon  the  more  or  less  conjectural  allowances 
estimated  by  tables,"  is  not  valid.1  The  result  is  only  a 
rough  approximation  in  either  case. 

But  here,  as  elsewhere,  the  "valuations"  made  by  the 
States  have  presented  figures  purporting  to  be  accurate  to 
the  final  cent.  The  Washington  "valuation"  applied  the 
use  of  "life  tables"  to  parts  of  the  depreciation  problem. 
This  expedient  rendered  "useless"  any  field  inspection  of 
equipment  and  structures.  The  life  tables  drawn  up  were 
not,  however,  based  upon  study  of  any  "mortality"  rec- 
ords of  the  roads  whose  property  was  appraised.  Instead 
Mr.  Gillette,  the  Chief  Engineer,  simply  referred  to  the 
"well-established  fact"  that  a  freight  car  has  a  useful  life 
exceeding  twenty  or  twenty-five  years.  So,  "if  the  average 
car  has  a  life  of  twenty-five  years  it  loses  four  per  cent 
of  its  life  every  year.  Hence  by  multiplying  its  age  in 
years  by  four  per  cent,  its  lost  life  or  depreciation  is  ac- 

sider  it  fair  to  make  deductions  for  anything  but  the  present  physical  con- 
dition, and  for  items  where  it  is  plainly  apparent  that  the  property  has 
become  obsolete  or  inadequate.  The  usual  estimate  of  the  life  of  dif- 
ferent parts  of  a  public  service  property,  so  far  as  they  deal  with  ob- 
solescence or  inadequacy,  are  extremely  problematical  and  these  ele- 
ments should  not  be  generally  taken  into  account  in  determining  present 
value." 

The  Valuation  Brief  of  1915  (page  256):  "In  the  past  many  items  of 
property  have  been  retired  because  of  obsolescence  and  inadequacy. 
The  causes  of  the  replacements  do  not  appear  in  the  records  of  the  car- 
riers, and  it  is  impossible  to  ascertain  therefrom  what  replacements  were 
due  to  age  and  use.  As  obsolescence  and  inadequacy  are  not  to  be  con- 
sidered in  the  ascertainment  of  cost  of  reproduction  less  depreciation, 
there  are  no  statistics,  either  in  the  carriers'  records,  or  elsewhere,  which 
furnish  reliable  information  as  a  guide  to  determine  the  average  life,  when 
use  and  age  alone  are  considered,  upon  which  to  make  mortality  tables." 

1  Gately  &  Hurley  v.  Delaware  &  Atlantic  T.  &  T.  Co.,  1  N  J.B.P.U.C. 
519,  551. 


82  RAILROAD   VALUATION 

curately  ascertained."  1  Making  an  allowance  of  ten  per 
cent  of  original  cost  for  salvage,  and  assuming  a  life  of 
twenty-five  years,  he  secured  a  rate  of  3.6  per  cent  per 
year. 

The  purely  arbitrary  basis  of  this  assumption  is  further 
emphasized  by  the  fact  that  the  same  figure  (3.6  per  cent) 
was  applied  to  all  roads  alike,  and  to  freight  and  passen- 
ger cars  indiscriminately,  and  to  locomotives.2  But  the 
"findings"  of  the  Washington  Commission  are  so  incom- 
plete that  the  exact  method  of  calculation  of  the  amount 
of  accrued  depreciation  does  not  appear.  It  seems  certain, 
however,  that  average  was  piled  on  average.  For  example, 
the  freight  cars  of  the  Northern  Pacific  (the  "  cost  of  repro- 
duction" being  calculated  as  $8,040,254.90)  had  been  in 
use  "an  average  of  8.2  years,  with  an  annual  depreciation 
of  approximately  3.6  per  cent."  Accordingly  "the  present 
depreciated  value  of  such  freight  equipment"  was  found  to 
be  $5,668,379.72.  This  same  equipment  had  cost  new  (so 
the  report  found)  $5,665,563.95,  or  about  $3000  less  than 
the  "present  value,"  calculated  on  the  "cost  of  reproduc- 
tion less  depreciation"  hypothesis.  Since  the  latter  figure 
is  exactly  70.5  per  cent  of  the  "cost  of  reproduction  new," 
the  conclusion  seems  not  unwarranted  that  the  amount 
of  the  accrued  depreciation  was  determined  by  using  the 
"average  life"  as  a  multiplier.3  Yet  this  manipulation  of 
averages  and  approximations  brought  results  which,  as  re- 
ported, assumed  entire  accuracy.  By  substantially  similar 
methods  Mr.  Gillette  found  the  amount  of  accrued  depre- 
ciation in  buildings.4  Enough  has  been  said,  however,  to 

1  Second  and  Third  Annual  Reports,  Railroad  Commission  of  Wash- 
ington, page  44.    The  italics  are  the  writer's. 

2  Ibid.,  page  156,  N.P.;  page  282,  G.N. 

»  Ibid.,  page  156.  The  product  of  3.6  and  8.2  is  29.52. 

4  Ibid.,  page  45.  See  page  289  where  the  "  value  "  of  the  Great  North- 
ern shops,  roundhouses,  and  turntables  is  shown  as  "  approximately  84 
per  cent "  of  the  "  value  new  "  (cost  of  reproduction).  Throughout  the 
report  the  phrase  "cost  of  reproduction"  is  assumed  as  equivalent  to 
"value,"  and  is  used  indiscriminately  with  it. 


PHYSICAL  VALUATION  83 

indicate  the  lack  of  binding  significance  in  such  conclu- 
sions. 

When  it  is  realized  that  inspection  seeking  to  measure 
depreciation  has  been  similar  to  that  used  in  checking  in- 
ventories taken  from  the  records,  the  entire  lack  of  accuracy 
is  again  readily  apparent.  Yet  Mr.  C.  C.  Witt,  the  South 
Dakota  Chief  Engineer  (his  inspection  like  that  in  Minne- 
sota and  Nebraska  was  made  from  a  slowly  moving  train), 
could  report  to  that  Commission:  "The  present  actual 
condition  of  each  item  due  to  use  or  decay  was  noticed  and 
a  condition  per  cent  based  on  a  new  or  one  hundred  per 
cent  condition  was  placed  opposite  each  item  on  the  in- 
ventory." 1  In  the  New  Haven  Validation  appraisal, 
though  the  entire  mileage  was  covered  in  twelve  days,  it 
was  "  the  unanimous  testimony  of  every  one "  that  the 
road  was  "  maintained  in  remarkably  good  condition."  The 
depreciation  percentages  were  "fixed  accordingly,"  with 
but  three  exceptions,  on  a  figure  which  was  a  multiple  of 
five.2  In  the  Michigan  and  Wisconsin  appraisals  every- 
thing was  left  to  the  judgment  of  the  individual  inspectors. 
Mr.  Cooley's  report  to  the  Michigan  Tax  Commission  did 
show  that  "about  33,000  freight  cars  were  inspected,"  that 
"experienced  railroad  engineers  .  .  .  made  a  personal  in- 
spection of  all  the  separate  items  .  .  .  ties,  rails,  frogs, 
switches,  etc.,  .  .  .  the  condition,"  etc.3  If  this  inspec- 

See  Report  of  W.  S.  Thorington,  Special  Master,  Central  of  Georgia 
Case,  pages  138-41.  Here  different  rates  of  depreciation  were  used  for 
different  classes  of  locomotives,  for  wood  and  steel  cars,  etc. 

1  South  Dakota  Railway  Appraisal,  Report  of  C.  C.  Witt  (1910), 
page  9. 

2  These  percentages  were  applied  to  the  total  for  each  group  of  the 
inventory;  e.g.,  cost  of  reproduction  new  (Mr.  Swain  called  this  "value") 
of  rails  was  $8,775,985;  their  condition,  80  per  cent;  etc.  The  summary 
is  found  in  the  New  Haven  Validation  Report,  page  133;  the  discussion, 
page  91.    Mr.  Swain  felt  that  the  figures  submitted  over  his  signature 
(they  had  been  made  "with  as  much  care  as  the  time  would  permit") 
were  "exceedingly  fair  and  reliable,"  "low,"  "conservative"  (page  91); 
"safe  and  reliable"  (page  127). 

8  Bulletin  21,  Bureau  of  the  Census,  Commercial  Valuation  of  Railway 


84  BAILROAD  VALUATION 

tion  was  really  made,  it  is  difficult  to  see  how  Mr. 
Morgan,  of  Minnesota,  justified  his  claim  to  greater 
thoroughness.  For,  let  it  be  recalled,  the  most  that  he  did 
was  to  stop  his  train  "every  mile  in  places,  but  usually 
every  two  miles  and  sometimes  every  five  miles."  l  Except 
as  making  possible  a  determination  of  the  standards  of 
"maintenance"  without  reliance  upon  reports  of  subor- 
dinates, it  is  difficult  to  see  that  this  process  was  necessarily 
more  accurate  than  that  in  the  New  Haven  appraisal.2  In 
neither  case  was  the  accuracy  warranted  which  the  com- 
pleteness of  the  figures  reported  would  imply.  Mr.  Swain 
reported  a  "present  valuation  new,"  for  the  New  Haven 
of  $304,601,824,  a  "present  valuation  depreciated,"  of 
$263,601,136;  Mr.  Morgan,  a  "cost  of  reproduction  new," 
of  $69,397,954.87  for  the  Minnesota  lines  of  the  Northern 
Pacific,  a  "present  value"  of  $61,099,563.40.  The  corre- 
sponding figures  for  the  Great  Northern  were  $107,074,102.18 
and  $94,415,342.69,3  etc.,  etc. 

Operating  Property,  page  77;  see  page  83,  the  "plan"  of  W.  D.  Taylor, 
the  Wisconsin  Chief  Engineer. 

1  Supplement,  Report,  Railroad  &  Warehouse  Commission  of  Minne- 
sota, 1908,  page  23.  In  the  Washington  appraisal,  where  inspection  was 
used  for  properties  other  than  structures  and  equipment,  the  estimates 
were  prefaced  by  "approximately."  Thus  the  "present  value"  of  bridges, 
trestles,  etc.,  on  the  Northern  Pacific  was  "approximately  84.7  per  cent." 
Second  and  Third  Annual  Reports,  Railroad  Commission  of  Washington, 
page  155. 

2  The  most  absurd  performance  of  all  —  no  milder  phrase  is  adequate 
—  was  that  of  the  Wisconsin  Commission  in  Milwaukee  v.  M.E.R.  &  L. 
Co.,  10  W.R.C.R.  1  (1910).   An  appraisal  made  in  1897  had  omitted  to 
estimate  any  accrued  depreciation.    "It  is  probable,  however,"  said  the 
Commission,  "that  the  property  was  in  what  may  be  regarded  as  about 
a  77.62  per  cent  condition"  (page  87). 

1  The  New  Haven  Validation  Report,  page  134.  Mr.  Swain  called  "cost 
of  reproduction,"  "value."  Supplement,  Report,  Railroad  &  Warehouse 
Commission  of  Minnesota,  1908,  pages  82  and  91.  Mr.  Morgan's  figures 
are  all  given  with  the  same  fullness,  pages  36  to  158.  See  also  the  re- 
ports cited  above,  page  31. 


CHAPTER  IV 

PHYSICAL  VALUATION 

"COST  OF  REPRODUCTION"  (concluded) 

Introduction:  The  test  of  certainty,  85. 

I.  The  "cost  of  reproduction"  hypothesis,  85. 

Agricultural  land,  86.  —  Urban  land,  87.  —  Terminals,  89.  — 
The  Minnesota  Rate  Cases,  90.  —  Capital  goods,  94. 
II.  "Cost  of  reproduction"  and  reasonableness,  96. 

Courts  and  Commissions,  97.  —  The  engineers,  97.  —  The  pri- 
vate interest,  101.  —  "Cost  of  reproduction"  and  the  "  long  run" 
cost  of  producing  transportation  service,  102. 

To  this  discussion  of  "cost  of  reproduction"  can  now  be 
brought  a  significant  passage  from  the  Minnesota  Rate 
Cases:  "The  cost  of  reproduction  method  is  of  service  in 
ascertaining  the  present  value  of  the  plant,  when  it  is 
reasonably  applied,  and  when  the  cost  of  reproducing  the 
property  may  be  ascertained  with  a  proper  degree  of  cer- 
tainty." l  This  sentence  standing  alone  is  quite  character- 
istic of  the  guarded  manner  in  which  the  Court  has 
always  treated  the  valuation  problem.  The  range  of  dis- 
cretion is  necessarily  wide.  What  is  a  "reasonable" 
application  of  the  "cost  of  reproduction"  method?  What 
is  a  "proper  degree  of  certainty"?  So  far  as  Justice 
Hughes  may  be  said  to  have  voiced  a  standard  it  is  found 
in  his  refusal  to  accept  "results  which  depend  upon  mere 
conjecture."  2 


Justice  Hughes*  criticism  went  to  the  heart  of  the  "cost 
of  reproduction"  hypothesis,  and  especially  as  that  hy- 
pothesis has  been  applied  to  the  "valuation"  of  land. 

1  230  U.S.  352,  452.  »  Ibid. 


86  RAILROAD   VALUATION 

The  expedient  used  by  both  parties,  it  will  be  recalled, 
had  been  a  "valuation"  of  the  railroad  land  based  upon 
the  value  of  adjacent  tracts.  That  the  House  draft  of  the 
Valuation  Law  provided  for  the  determination  of  the 
"present  value  of  all  lands,  rights  of  way,  and  terminals 
.  .  .  ascertained  by  comparison  with  adjoining  lands,'*  is 
testimony  to  the  strength  of  the  tradition.1  And  this  tra- 
dition is,  of  course,  a  simple  corollary  of  the  condemnation 
analogy,  and  its  concomitant,  the  "cost  of  reproduction" 
hypothesis.  For  this  hypothesis  assumes  that  the  value  of 
the  adjacent  land,  due  in  part  to  the  presence  of  the  rail- 
road, shall  persist  even  though  the  railroad  is  conjured 
away.  To  what  extent,  if  at  all,  is  the  hypothesis  valid? 

Take  first  the  situation  of  agricultural  land:  eliminate 
the  railroad;  what  would  the  land  be  worth,  deprived  of 
a  mode  of  transporting  to  market?  Or  take  the  case  of  a 
railroad  built  into  a  virgin  territory:  land  formerly  not 
worth  cultivating  can  at  once  be  tilled.  Or  if  the  road 
brings  transportation  facilities  nearer  to  areas  already 

1  Amended  in  the  Senate.  See  Senate  Report  on  Valuation,  page  20. 

The  scope  of  the  Federal  investigation  is  outlined  in  the  following  quo- 
tation from  an  address  of  Director  of  Valuation  Prouty  before  the  Na- 
tional Association  of  Railway  Commissioners  (Proceedings,  26th  Annual 
Meeting,  page  136).  No  originality  of  method  is  apparent  in  the  investi- 
gation here  outlined:  a  combination  of  tax  ratio,  and  opinion  and  sales 
"value"  —  and  judgment!  "Now  there  are  a  great  many  questions  in 
reference  to  land  which  are  very  difficult  and  delicate  questions,  and 
which  must  be  passed  upon  by  the  Commission  finally.  Those  questions 
have  not  been  reached  by  us  up  to  the  present  time,  and  the  work  which 
we  are  doing  now  merely  concerns  the  collection  of  facts  with  respect  to 
land.  In  other  words,  we  are  attempting  to  ascertain,  and  we  are  only  at- 
tempting to  ascertain,  what  is  the  value  of  similar  adjacent  and  adjoining 
lands.  In  doing  that  we  look  into  the  tax  assessment  of  similar  lands, 
endeavoring  to  ascertain  the  relation  between  that  assessment  and  the  actual 
value  of  the  land.  We  look  into  the  actual  sale  of  similar  lands,  comparing 
them  with  one  another.  We  take  the  opinions  of  people  who  are  qualified 
to  judge,  and  our  land  appraiser,  from  all  those  sources,  makes  up  his  mind 
and  so  reports  as  to  the  value  of  similar  adjacent  lands."  The  italics  are 
the  writer's. 

See  circulars  issued  by  the  General  Secretary  of  the  Presidents'  Con- 
ference, dated  October  30, 1914,  November  30,  1915;  and  May  14,  1916. 


PHYSICAL  VALUATION  87 

served,  a  parallel  increase  in  value  appears,  with  the  lessen- 
ing of  cost  of  haulage  to  the  railroad.  In  either  case  wider 
markets  are  made  available;  normally  "economic  rent" 
must  increase;  the  adjacent  lands  are  more  valuable.  So 
much  is  commonplace  history  of  the  American  West. 

Or  consider  the  value  of  land  in  villages  and  the  smaller 
towns  served  by  a  single  road.  Not  infrequently  the  rail- 
road itself,  especially  when  extending  into  relatively  un- 
settled areas,  has  plotted  the  town  sites,  and  sold  single 
lots  for  sums  which,  before  the  coming  of  the  road,  would 
have  bought  acres.  Sometimes  an  enterprising  promoter 
has  done  the  work  of  exploitation.  But  in  either  case,  de- 
priving the  town  of  the  railroad  would  destroy  the  site 
rent.  The  land  would  become  valueless  (except  where 
available  for  agriculture).  Again  the  value  of  lands  adja- 
cent to  the  railroad  is  seen  to  depend  directly  upon  the 
presence  of  the  railroad.1 

Nor  is  the  situation  different  where  a  number  of  roads 
have  centered,  and  a  city  —  large  or  small  —  has  grown  up. 
Even  where  location  on  a  navigable  waterway  originally 

1  The  following  testimony  of  J.  J.  Hill  in  the  Minnesota  Rate  Cases  is 
here  pertinent : 

"Q.  Now,  it  has  been  suggested  that  the  location  of  a  railroad  in  the 
different  towns  and  cities  and  villages  through  which  it  passes  has  a  great 
deal  to  do  in  considering  the  value  of  the  property;  if  the  location  is  cen- 
tral and  convenient  to  the  business,  it  is  one  thing,  and  if  it  is  remote  and 
on  the  outskirts  of  a  town,  it  is  another  thing.  Now,  how  is  the  Great 
Northern  Road,  in  the  State  of  Minnesota,  generally  speaking,  located 
in  the  different  towns  and  cities  and  villages  through  which  it  passes  ? 

"A.  Well,  it  was  very  largely  located  and  built  there  before  the  town 
was;  the  town  formed  on  the  railroad. 

"Q.  Does  that  have  a  direct  influence  on  the  business  which  the  Com- 
pany gets? 

"A.  The  railroad  was  in  the  middle  of  the  business;  the  business 
formed  around  it,  and  it  was  more  convenient,  much  more  than  if  it  had 
located  some  distance  out. 

"Q.  Taking  the  location  here,  in  the  city  of  St.  Paul  and  in  the  city  of 
Minneapolis,  is  that  true  here  as  in  the  other  places  you  have  referred  to? 

"A.  Yes,  sir." 

Record  (G.N.),  page  1290. 


88  RAILROAD  VALUATION 

marked  out  a  spot  for  settlement  —  typical  illustrations 
are  the  "fall  line"  cities  in  the  South,  and  the  cities  at 
strategic  points  on  the  Mississippi  —  the  coming  of  the 
railroad  has  meant  increasing  population  in  the  city  itself, 
and  in  the  surrounding  country.1  A  navigable  waterway 
has  not  been  essential;  "railroad  "  towns  have  developed  at 
junction  points.  Perhaps  the  most  conspicuous  case  of  the 
railroad  center,  per  se,  is  Atlanta,  where  converge  the  lines 
into  the  Southeast  from  the  North  and  West.  A  great 
industrial  and  commercial  city  has  been  the  result.  And 
varying  only  in  degree,  the  same  is  true  of  nearly  every 
American  town.  The  "cost  of  reproduction"  hypothesis 
as  applied  to  land  simply  closes  its  eyes  to  this  relationship. 
The  value  of  urban  land  —  in  city  or  town  —  is  itself 
dependent  upon  the  presence  of  the  railroad.  "If  there 
were  no  railroads  in  Chicago,  there  would  be  no  Chicago." 2 


1  Adna  F.  Weber,  The  Growth  of  Cities,  pages  197-204,  summarizes 
the  influence  of  railroad  building  upon  city  growth. 

2  Evidence,  1910  Advances,  page  1002;  testimony  of   Mr.  Ward, 
General  Manager  of  the  C.  B.  &  Q.;  Mr.  Lyon,  the  attorney  for  the  Com- 
mission, cross-examined  Mr.  Ward  (pages  1001-10) : 

"Mr.  Lyon.  Why,  in  valuing  this  property,  did  you  base  it  upon  sur- 
rounding property  used  for  other  purposes? 

"Mr.  Ward.  Because  I  was  attempting  to  get  at  the  valuation  for 
reproducing  our  property,  and  that  seemed  to  be  the  only  practicable 
basis  to  use. 

"Mr.  Lyon.  If  your  railroad  was  entirely  removed,  would  you  express 
any  opinion  as  to  what  adjoining  property  would  be  worth?  .  . . 

"Mr.  Ward.  It  would  undoubtedly  decrease.it. 

"Mr.  Lyon.  So  the  value  of  the  adjoining  property  upon  which  you 
estimate  the  value  of  the  railroad  property  is  valuable  because  the 
railroad  is  there? 

"Mr.  Ward.  Partly  so;  yes,  sir. 

"Mr.  Lyon.  And  therefore  do  you  consider  the  fact  that  there  is  an 
operating  railroad  there  makes  the  value  of  the  adjoining  property  to  a 
large  extent?  That  is  true  to  a  large  extent,  is  it  not?  .  .  . 

"Mr.  Ward.  Yes,  sir;  it  draws  part  of  its  value  from  that  fact. 

"Mr.  Lyon.  Is  the  right  of  way  estimated  the  same  way? 
:    "Mr.  Ward.  Yes."  (Page  1002.) 

And  further: 

"Mr.  Lyon.   And  that  land  which  you  say  you  would  not  give  $25 


PHYSICAL  VALUATION  89 

Especially  strained  is  the  theory  which  within  a  given 
city  measures  the  value  of  terminals  by  the  value  of  adja- 
cent lands  devoted  to  business  purposes.  Sites  near  the 
railroads  are  sought  after  for  business  purposes,  because 
such  location  means  more  economical  handling  of  goods  in 
and  out  of  the  plant.  The  possession  of  a  side  track  where 
delivery  to  the  road  can  be  made  without  team  hauling  is 
an  advantage  for  which  the  industry  is  ready  to  bid.  For 
elevator  and  warehouse  purposes  such  ready  access  is  all 
essential.1  And  even  where  delivery  must  be  made  to  a 

an  acre  for  in  western  Nebraska  you  include  in  this  group  at  $2000  a  mile, 
which  is  $165  an  acre? 

"  Mr.  Ward.  You  understand  that  includes  our  station  grounds,  as  well 
as  the  ordinary  right-of-way  strip. 
'  Mr.  Lyon.  Station  grounds  ? 
4  Mr.  Ward.  Yes,  sir. 

'Mr.  Lyon.  You  could  buy  enough  ground  in  western  Nebraska  to 
put  all  your  stations  on  for  $25. 
'  Mr.  Ward.  Oh,  no. 
'  Mr.  Dawes.   Not  located  at  the  stations. 
'  Mr.  Ward.  Not  located  at  the  stations. 

'  Mr.  Lyon.  That  is  another  case  in  which  land  at  the  station  becomes 
more  valuable  because  the  railroad  is  there,  and  therefore  it  should  be 
capitalized  and  rates  paid  on  it? 

"Mr.  Ward.  Exactly."     (Page  1006.) 

See  also  testimony  of  L.  B.  Elwood  in  the  Minnesota  Rate  Cases, 
Record  (N.P.),  page  1046,  and  of  J  .F.  Stevens,  ibid.  (G.N.),  pages  473-74; 
and  the  Report  of  W.  A.  Gunter,  in  the  Louisville  &  Nashville  Case,  page 
84,  which  indicates  that  the  issue  was  there  raised;  also  Shepard  v.  N.P. 
Ry.  Co.,  184  Fed.  765,  803. 

1  J.  J.  Watson,  one  of  the  St.  Paul  appraisers,  Minnesota  Rate  Cases, 
Record  (N.P.),  page  524  and  following,  especially  page  527;  and  Charles 
Hayden,  the  Assistant  Right  of  Way  Commissioner  of  the  Great  North- 
ern, Record  (G.N.),  page  276. 

The  following  is  from  the  testimony  of  O.  L.  Taylor  of  the  St.  Paul 
appraisers: 

"  Q.  Now,  of  course,  when  you  speak  about  the  property  being  more 
valuable  in  the  wholesale  district,  you  are  considering  adjacent  property, 
aren't  you? 

"  A.  Yes,  the  adjacent  property.  .  .  . 

"  Q.  It  would  be  impossible  for  you  to  say  whether  the  railroads  had 
given  the  value  to  the  wholesale  property  or  the  wholesale  property  had 
given  the  value  to  the  railroad  property,  wouldn't  it  — -  you  can't  tell 
that? 


90  RAILROAD  VALUATION 

freight  house,  land  nearer  the  terminal  normally  possesses 
a  differential  advantage  measured  by  the  difference  in 
teaming  costs.  Competition  for  these  desirable  locations 
consequently  means  valuations  measured  by  the  capitaliza- 
tion of  the  differential  in  terms  of  dollars  and  cents.  Except 
for  the  presence  of  the  railroad  in  the  river  bottom  the 
business  district  of  St.  Paul  would  hardly  have  concen- 
trated in  its  present  position.  And  the  fact  that  the 
Northern  Pacific  secured  high  rents  for  sites  located  along 
its  tracks  proved  nothing  about  the  value  of  the  same  lands 
were  the  road  removed.  This  is  again  the  most  elementary 
economic  theory.1 

Justice  Hughes  did  not  hesitate  to  challenge  the 
"speculative"  nature  of  the  "cost  of  reproduction" 
hypothesis  as  applied  to  the  conjectured  cost  of  reacquir- 
ing  land.  "The  railroad,"  he  said,  "has  long  been  estab- 
lished; to  it  have  been  linked  the  activities  of  agriculture, 
industry,  and  trade.  Communities  have  long  been  depend- 
ent upon  its  service,  and  their  growth  and  development 
have  been  conditioned  upon  the  facilities  it  has  provided. 
.  .  .  The  assumption  of  its  non-existence,  and  at  the  same 
time  that  the  values  that  rest  upon  it  remain  unchanged, 
is  impossible  and  cannot  be  entertained."  2 

Had  Justice  Hughes  stopped  with  this  incisive  analysis 

"A.  No;  I  think  there  has  been  a  mutual  effect. 

"  Q.  Mutual  effect;  it  has  all  gone  on  together? 

"A.  Yes. 

"  Q.  And  when  you  come  to  the  point  of  one  eliminated  and  the  other 
existing,  you  are  getting  into  a  range  of  speculation  which  a  hard-headed 
real  estate  man  like  yourself  doesn't  indulge  in,  isn't  that  so? 

"A.  True,  yes."  Record  (G.N.),  page  490. 

1  See  Brief  of  J.  M.  Woolworth,  page  59.  Smyth  v.  Ames,  169  U.S.  466. 
Similar  reasoning  can  be  applied  in  essential  particulars  to  the  case  of 
passenger  terminals,  though  the  relationship  is  here  one  to  the  entire 
business  section  as  contrasted  with  the  factory  and  warehouse  section. 

2  Minnesota  Rate  Cases,  230  U.S.  352,  452.   This,  of  course,  directly 
overruled  Judge  Sanborn,  Shepard  v.  N.P.  Ry.  Co.,  184  Fed.  765,  803. 
See,  however,  a  circular  issued  by  the  General  Secretary  of  the  Presi- 
dents' Conference,  dated  May  14,  1915. 


PHYSICAL  VALUATION  91 

of  the  adjacent  land  test,  the  decision  in  the  Minnesota 
Rate  Cases  would  constitute  a  more  helpful  guide  to  a  dis- 
cussion of  the  problem  of  land  "valuation."  But  appar- 
ently seeking  to  protect  the  Court  from  too  positive  a 
statement  overthrowing  the  tradition  of  practice,  he  intro- 
duced a  new  complication.  Making  certain  assumptions 
(but  without  committing  the  Court  to  the  assumptions),  he 
suggested  a  programme  for  land  appraisal  which  aimed  to 
set  the  maximum,  should  the  assumptions  be  held  valid. 
His  words  are,  therefore,  from  the  point  of  view  of  judicial 
authority,  mere  dicta,  —  "Assuming  that  the  company  is 
entitled  to  a  reasonable  share  in  the  general  prosperity  of  the 
communities  which  it  serves,  and  thus  to  attribute  to  its 
property  an  increase  in  value,  still  the  increase  so  allowed 
.  .  .  cannot  extend  beyond  the  fair  average  of  the  normal 
market  value  of  land  in  the  vicinity  having  a  similar  char- 
acter. Otherwise  we  enter  the  realm  of  mere  conjecture."  l 

"  The  fair  average  of  the  normal  market  value  of  land  in  the 
vicinity  having  a  similar  character'9  —  what  does  it  mean? 
Does  this  in  any  sense  eliminate  the  element  of  speculation 
and  conjecture?  On  the  contrary,  there  is  no  such  thing  as 
a  "normal"  market  value  of  land.  The  value  of  land  is 
dependent  upon  the  capitalization  of  the  economic  rent  of 
that  land.  A.  fair  average  of  a  series  of  unrelated  real  estate 
values  is  quite  as  speculative  as  Mr.  Morgan's  attempt  to 
group  lands  of  similar  character  in  order  to  apply  his  sales- 
assessment  method.  Not  infrequently,  too,  the  railroad 
occupies  land  which  is  the  only  land  of  that  character  for 
miles  around.  How  apply  Justice  Hughes'  test  to  the 
possession  of  the  river-bank,  or  of  the  mountain  pass? 
For  any  purpose,  except  for  that  of  transportation,  these 
sites  might  conceivably  be  quite  valueless.  Or  in  the  vil- 
lage, is  a  line  to  be  surveyed  away  from  the  existing  line, 
and  the  value  of  lands  located  in  the  path  of  this  substitute 
line  applied  to  the  acreage  in  the  right  of  way?  And  take 

1  Minnesota  Rate  Cases,  230  U.S.  352, 455;  the  italics  are  the  writer's. 


93  RAILROAD   VALUATION 

the  case  of  the  terminal  in  the  city.  Who  is  to  say  which  of 
a  series  of  locations  is  suitable  for  a  railroad — assuming 
that  there  is  similar  land  in  the  city,  that  the  railroads 
are  not  confined  to  a  water  front,  again  in  many  cases  a 
conjecture  contrary  to  fact?  In  a  city  there  is  by  no  pos- 
sible stretch  of  truth  such  a  thing  as  "similar  land,"  as 
applied  to  large  areas. 

The  value  of  a  piece  of  land,  the  physical  characteristics 
of  which  may  be  the  same  as  that  owned  by  the  railroad,  is 
determined  by  the  "rent "  which  it  will  yield  used  for  busi- 
ness or  residence  purposes.  And  the  amount  of  this  rent 
depends  upon  a  series  of  complicated  factors.  Of  these 
the  presence  of  the  railroad,  as  Justice  Hughes  himself 
pointed  out,  is  one.  Urban  site  rent  does  not  depend  upon 
fertility;  it  depends  upon  availability  for  other  than  rail- 
road purposes.  Urban  land  (including  land  in  the  smallest 
village  as  well  as  the  great  city)  no  more  possesses  a  normal 
market  value  than  does  land  in  the  agricultural  country.  It 
has  no  cost  of  production;  its  value  is  dependent  upon  the 
income  which  it  will  yield;  and  the  amount  of  that  income, 
even  in  the  case  where  land  of  similar  physical  character- 
istics might  be  found,  is  dependent  upon  the  presence  of 
the  railroad.  The  influence  of  the  transportation  facilities 
upon  land  values  in  city  or  country  is  not  confined  to  the 
land  immediately  adjacent.  Justice  Hughes'  proposed  so- 
lution must  fail,  therefore,  upon  the  two  grounds  on  which 
he  rejected  the  "adjacent  land"  test:  conjecture  and  inter- 
dependence. The  use  of  the  phrase  "fair  average  of  the 
normal  market  value  of  land  having  similar  character*' 
simply  served  to  hide  a  failure  to  continue  economic 
reasoning  in  treating  this  portion  of  the  problem.1  It  is 

1  J.  E.  Baker,  "Valuation  of  Terminal  Lands,"  suggests  that  the 
"values"  allotted  to  terminals  be  what  would  be  their  value,  if  devoted 
to  business  purposes,  the  railroad  removed,  but  the  city  remaining.  "  It 
is  not  difficult,"  he  says,  "  for  observers  of  population  movements  and 
urban  conditions  to  determine  quite  accurately  to  what  purpose  a  given 
location  would  be  devoted  if  another  hypothetical  condition  be  assumed. 


PHYSICAL   VALUATION  93 

indication  that  the  Supreme  Court  is  still  seeking  a  con- 
cept of  "fair  value." 

The  Court's  assurance  that  "  otherwise  we  enter  the 
realm  of  mere  conjecture"  is  not  conclusive.  Who  but  the 
expert  is  to  say  what  land  possesses  a  "similar  character," 
especially  in  view  of  the  peculiar  need  of  the  railroad  for  a 
site  which  conforms  to  standards  for  maximum  grade  and 
curvature?  Justice  Hughes'  substitute  for  the  "adjacent 
land"  test  must  simply  be  written  down  as  a  resort  to 
generality.  It  does  not  avoid  the  very  difficulty  which 
it  purports  to  seek  to  avoid:  the  dependence  of  land  val- 
ues upon  the  presence  of  the  railroad.  The  effect  of  the 
presence  of  transportation  facilities  upon  land  values  is 
not  limited  to  a  strip  immediately  adjacent  to  the  right 
of  way.1  To  base  a  decision  involving  broad  questions 
of  public  policy  upon  the  opinions  of  "experts"  testifying 
both  as  to  "average  value"  and  "similarity"  of  character 
would  throw  down  the  bars  to  a  revelry  in  conjecture. 

Justice  Hughes  also  rejected  "hypothetical  outlays," 
including  not  only  the  "conjectural  cost  of  acquisition  and 
consequential  damages"  (covered  by  the  land  multiple), 
but  also  the  sums  calculated  "on  the  amount  taken  as  the 
present  value  of  the  lands,"  which  were  embraced  in  the 
items  of  engineering,  superintendence,  legal  expenses, 
contingencies,  and  interest  during  construction.2  These 
amounted  in  the  case  of  the  Northern  Pacific  to  $4,099,- 
790.  In  answer  to  Justice  Hughes,  it  might  well  be 

...  If  a  Marshall  Field  store  would  be  built  upon  it,  use  a  Marshall  Field 
price.  But  if  a  lot  would  be  used  for  storing  rags  and  old  iron,  mark  it 
down  to  a  remnant  figure."  Journal  of  Accountancy,  volume  8,  pages 
246,  247. 

1  Thus  Justice  Hughes'  proposal  is  seen  to  be  no  less  conjectural  than 
the  so-called  "sales  and  assessment"  method  which  is  based  entirely 
upon  the  hypothesis  of  a  "judicial  process"  working  subconsciously; 
or  upon  the  "sales"  method  which  purports  to  check  the  "mental  proc- 
ess" of  the  local  real  estate  expert.  See  State  Journal  Printing  Co.  t>. 
Madison  G.  &  E.  Co.,  4  W.R.C.R.  501,  528. 

8  Minnesota  Rate  Cases,  230  U.S.  352,  455. 


94  RAILROAD   VALUATION 

asserted  that  he  did  not  meet  the  issue  fairly,  since  there 
had  been  no  claim  that  the  percentage  figures  were  more 
than  "average"  allowances.  The  very  hypothesis  upon 
which  the  engineers  made  their  estimates  of  cost  for  the 
"overhead,"  including  "contingencies,"  was  that  the  per- 
centages, as  calculated  against  the  totals,  were  "fair" — 
not  that  they  applied  equally  to  each  item  of  the  inventory. l 
That  the  "contingencies"  item,  the  "engineering"  and 
"legal"  items,  and  "interest"  were  dependent  upon  con- 
jecture for  their  amount,  and  that  to  varying  degree  they 
covered  "hypothetical  outlays,"  is,  however,  true. 

But  for  what  item  of  "the  cost  of  reproduction"  is  this 
not  true?  In  the  particular  case  which  Justice  Hughes  was 
considering,  the  figures  were  not  even  "expert"  guesses, 
being  simply  the  arbitrary  figures  picked  out  of  a  maze  of 
conflicting  testimony  by  an  attorney,  entirely  new  to  his 
task.  But  even  had  the  Master  simply  accepted  without 
change  the  estimates  of  the  railroad  engineers  or  those 
of  Mr.  Morgan  for  the  State,  the  previous  discussion  has 
shown  that  conjecture  was  perhaps  the  largest  source  of 
information  used  by  these  authorities.  The  entire  esti- 
mates represented  "hypothetical  outlays."  The  "cost  of 
reproduction"  is  all  hypothesis. 

It  hardly  needs  a  summary  of  the  conjectural  factors 
to  fortify  this  conclusion.  The  making  of  an  inventory 
of  physical  units  (or  quantities)  simply  as  such,  without 
attempt  to  classify  by  standards  of  quality,  of  material, 
even  of  age  (since  allowance  must  be  made  for  accrued 
depreciation),  is  necessarily  tainted  with  a  "large  measure 
of  error."  Even  "subordination  of  personality  to  system" 
can  hardly  eliminate  those  "  individual  errors  of  judgment 
.  .  .  frequent  in  any  work  of  magnitude."  2  But  the  task 
is  not  one  of  measurement  and  count  alone,  even  where 

1  Above,  page  49. 

2  H.  E.  Riggs,  "  Valuation  of  Public  Service  Property,"  Transactions, 
Am.  Soc.,  C.E.,  volume  72,  page  4. 


PHYSICAL  VALUATION  95 

well-defined  specifications  are  imposed  upon  the  engineer. 
The  physical  units,  before  they  can  serve  a  useful  purpose, 
must  be  translated  into  terms  of  the  monetary  unit.  Every- 
where is  found  reliance  upon  expert  knowledge,  judgment, 
"acquaintance  with  the  property,"  guessing,  where  guess- 
ing is  "analogous"  to  a  use  of  the  judgment,  —  in  short, 
reliance  upon  "railroad  intuition." 

The  complication  arising  from  inadequate  inventory 
figures  of  unit  quantities,  in  the  records  of  the  companies, 
and  that  due  to  lack  of  knowledge  of  the  probable  length  of 
life  of  the  railroad  plant,1  introduce  the  first  elements  of 
uncertainty  into  the  appraisal.  The  measurement,  count, 
and  classification  of  the  units  (the  last  perhaps  the  most 
significant  factor,  since  here  "judgment"  is  supreme),  and 
the  estimate  of  the  depreciation  accrued,  present  the  same 
inevitable  resort  to  "average"  figures,  to  approximation. 
The  use  of  percentages  for  "overhead"  charges  is  but 
further  extension  of  the  "average"  short  cut.  And  these 
difficulties  are  all  met  entirely  aside  from  any  determina- 
tion of  "unit  prices." 

Yet,  were  every  other  element  determined  within  so 
narrow  a  range  that  the  error  was  negligible,  the  necessity 
of  providing  "unit  prices"  would  throw  the  entire  "valua- 
tion" into  the  field  of  conjecture.  "Unit  prices"  must  be 
set  by  the  same  "experts"  who  draw  up  specifications. 
Resort  to  bulking,  "averaging,"  the  assumption  of  a 
similarity  of  condition  which  does  not  exist,  etc.,  —  these 
sources  of  error  appear  entirely  apart  from  the  general 
hypothesis.  The  latter  determines  whether  the  "prices" 
shall  be  "present"  prices,  "future"  prices  (the  only  basis 
true  to  a  reproduction  ideal),  or  "average"  prices.  Now 
add  to  these  complications  the  necessity  to  appraise  the 
accrued  depreciation,  and  the  task  of  the  "valuation" 
engineer  is  presented  in  full. 

1  Because  of  failure  to  keep  records  in  the  past,  and  because  of  the  ne- 
cessity to  consider  the  probable  course  of  progress  in  the  arts. 


96  RAILROAD   VALUATION 

In  hypothesis,  everything  is  simple  enough;  determine 
the  construction  (and  equipment)  quantities,  so  sub- 
divided and  graded  as  to  make  possible  the  application  of 
"fair  unit  costs,"  were  the  road  to  be  "reproduced."  With 
"cost  of  reproduction  new"  determined,  how  much  of  an 
investment  made  now  would  be  unimpaired  at  a  date 
when  the  "reproduced"  unit  should  be  depreciated  to  the 
condition  of  the  existing  unit?  The  task  that  this  pro- 
gramme proposes  is  one  which  must  be  fruitless  of  signifi- 
cant results  —  simply  from  the  point  of  view  of  statistical 
accuracy.  The  large  degree  of  error,  necessarily  attaching, 
must  vitiate  the  results  for  use  in  scientific  inquiry,  or  for 
inquiry  involving  so  broad  a  question  of  public  policy  as 
the  return  to  the  railroads,  when  that  inquiry  purports  to 
use  scientific  methods.  That  the  legal  profession,  with  un- 
reasoned dependence  upon  the  "rule"  in  Smyth  v.  Ames, 
and  the  engineering  profession,  with  optimism  unwarranted 
by  the  degree  of  accuracy  actually  attained,  have  used  such 
figures  is  evidence  only  of  the  hopelessness  of  the  task.  At 
best  all  that  "physical  valuation"  —  "cost  of  reproduc- 
tion "  —  can  do  is  to  offer  a  very  rough  and  uncertain 
approximation  upon  the  hypothesis  assumed.  Figures 
asserting  accuracy  are  as  dangerous  as  they  are  fallacious. 
We  need  not  marvel  at  Justice  Holmes'  protest  against 
"delusive  exactness."  l 


II 

We  turn  now  from  the  consideration  of  the  large  degree 
of  error  inherent  in  the  "cost  of  reproduction"  appraisal  to 
that  of  the  place  of  such  an  appraisal  in  a  scientific  (as 

1  Louisville  t>.  Cumberland  T.  &  T.  Co.,  225  U.S.  430,  436.  The  lower 
court  had,  however,  recognized  that  "  in  a  case  like  this,  there  is  no  pos- 
sibility of  scientific  accuracy."  Cumberland  T.  &  T.  Co.  v.  Louisville, 
187  Fed.  637,  649.  See  Spring  Valley  Water  Co.  v.  San  Francisco,  165 
Fed.  667,  685;  citing  eleven  appraisals  of  the  same  plant,  ranging  from 
twenty-two  to  seventy  millions  of  dollars. 


PHYSICAL  VALUATION  97 

differentiated  from  a  strategic)  measure  of  reasonable- 
ness. 

*  "A  fundamental,  though  not  necessarily  a  controlling 
element  in  value,  is  cost  of  reproduction.  This,"  declared 
the  Railroad  Securities  Commission, "  is  true  of  property 
in  general;  it  has  been  specifically  affirmed  of  railroad 
property  by  the  Supreme  Court  of  the  United  States. 
Eminent  railroad  men  who  have  appeared  before  this 
Commission  have  stated  that  in  their  opinion  cost  of  re- 
production or  physical  value  was  the  most  important  single 
element  in  determining  the  true  value  of  the  railroad  as 
a  whole."  1  In  this  language  is  briefly  summarized  the 
point  of  view  which  the  lower  courts  have  generally 
adopted  in  their  treatment  of  the  valuation  problem. 

Resort  to  "cost  of  reproduction"  can,  in  considerable 
measure,  be  accounted  for  on  the  ground  that  the  engi- 
neers have  consistently  defined  "present  value"  as  "cost 
of  reproduction,  less  depreciation."  The  State  appraisals 
have  here  been  at  one  with  those  made  by  private  interests, 

1  Report,  Railroad  Securities  Commission,  1911,  page  18.  The  Com- 
mission continued:  "  Indeed,  we  believe  it  to  be  in  the  interest  of  railroads, 
no  less  than  of  those  who  use  them,  that  the  Interstate  Commerce  Com- 
mission should  be  given  broad  powers  and  adequate  means  for  valuation 
of  the  physical  property  of  railroads  as  one  element  in  determining  fair 
value,  whenever,  in  the  judgment  of  that  Commission,  this  is  of  sufficient 
importance  to  warrant  such  action.  This  will  give  the  public  information 
which  it  is  entitled  to  demand,  and  which  can,  in  our  judgment,  be  better 
and  more  economically  obtained  in  this  way  than  in  any  other." 

Commissioner  Prouty  called  "cost  of  reproduction,  .  .  .  one  and  per- 
haps the  most  important  element  in  determining  'fair  value.' "  Eastern 
Advance  Case  of  1910,  20  I.C.C.  243,  261. 

See,  however,  the  incisive  testimony  of  Mr.  Frank  Trumbull,  of  the 
Chesapeake  &  Ohio,  before  the  Senate  Committee,  Senate  Report  on 
Valuation,  page  38;  likewise,  J.  F.  Stevens,  Minnesota  Rate  Cases,  Record 
(G.N.),  page  463;  and  J.  J.  Hill,  ibid.,  page  1351.  Mr.  Stevens  thought 
"cost  of  reproduction  .  .  .  perfectly  useless."  Mr.  Hill  did  not  "want  to 
testify  absolutely"  that  to  estimate  "cost  of  reproduction"  was  to  sup- 
pose "an  impossibility."  He  recognized,  however,  that  "the  reproduc- 
tion of  a  railway  of  2000  miles  is  something  that  has  never  been  done.  .  .  . 
It  is  very  hard  to  testify  as  to  what  would  be  accurate  in  a  case  that  has 
never  been  done." 


98  RAILROAD  VALUATION 

whether  railroads  or  local  public  utilities.1  The  courts, 
finding  the  "experts'*  (who,  be  it  remembered,  have  al- 
ways been  men  of  high  professional  standing)  ready  with 
a  definition,  seem  never  to  have  challenged  the  validity  of 
their  figures.  There  is  no  less  an  authority  than  a  decision 
of  the  Supreme  Court  holding  that  "the  cost  of  reproduc- 
tion is  one  way  of  ascertaining  the  present  value  of  the 

1  See  Bulletin  21,  Bureau  of  the  Census,  Commercial  Valuation  of  Rail- 
way Operating  Property,  page  78  (Michigan) ;  page  83  (Wisconsin) ;  Sup- 
plement, Annual  Report,  Railroad  &  Warehouse  Commission  of  Min- 
nesota, 1908,  page  30;  Second  and  Third  Annual  Reports,  Railroad  Com- 
mission of  Washington,  page  41;  the  New  Haven  Validation  Report, 
pages  152,  153;  Sixth  Annual  Report,  Nebraska  State  Railway  Commis- 
sion, page  522.  See  also  Reports  of  the  Masters  in  the  Alabama  Rate 
Cases;  and  the  cases  cited  in  Whitten,  Valuation  of  Public  Service  Cor- 
porations, pages  67,  70. 

WTien  cross-examined  by  the  attorneys  for  the  State,  A.  H.  Hogeland 
declared  that  his  "valuation"  of  the  Great  Northern  represented  not 
"value,"  but  "cost  of  reproduction."  Minnesota  Rate  Cases,  Record 
(G.N.),  page  67.  To  the  same  effect,  see  testimony  of  W.  L.  Darling, 
Record  (N.P),  pages  3241-43.  The  following  excerpt  indicates  the  tenor 
of  both  examinations:  t 

"Q.  You  have  assumed,  in  giving  this  statement,  that  the  method  pur- 
sued by  you  for  ascertaining  the  cost  of  reproduction  under  the  circum- 
stances described  by  you,  is  the  proper  method  of  ascertaining  the  value 
to  be  arrived  at  in  this  case? 

"Mr.  Darling.  I  have  made  no  estimate  on  the  value,  Mr.  O'Brien. 

"Q.  Made  no  estimate  on  the  value? 

"A.  No,  sir. 

"Q.  Well,  in  preparing  these  tables,  do  you  mean  that  you  did  not 
proceed  upon  the  theory  that  the  cost  of  reproduction  as  given  by  you 
would  show  the  value  of  the  road,  or  that  you  simply  adopted  the  theory 
which  you  were  instructed  to  adopt? 

"A.  No:  my  problem  in  this  was  merely  to  produce  the  cost  of  repro- 
ducing the  railroad  at  this  time. 

"Q.  And  in  doing  that  you  have  taken  the  literal  meaning  of  the  word 
'reproduction'  and  have  carried  it  to  the  full  extreme  under  all  circum- 
stances? 

"A.  I  have  given  what  I  think  is  a  conservative  cost  of  reproducing  the 
railroad."  (Page  3243.)  .  .  . 

"Q.  But  as  I  understand  it,  you  don't  present  your  tables  and  testi- 
mony with  the  claim  that  they  do  establish  the  actual  value  of  the 
Northern  Pacific  System,  either  in  Minnesota  or  outside  of  Minnesota,  as 
it  exists  at  the  present  time? 

"A.  No,  sir."  (Page  3246.) 


x  PHYSICAL  VALUATION  99 

r 

plant."  *  The  lower  court  in  the  New  York  Gas  Case  could 
not  observe  "the  continued  use  of  the  present  tense  in  the 
decisions  of  the  highest  court,  without  feeling  that  the 
actual  or  reproductive  value  at  the  time  of  inquiry  was  the 
first  and  foremost  figure  to  be  ascertained."  2  Or,  to  take 
the  holding  in  the  Alabama  Rate  Cases:  "After  finding  the 
original  cost  the  question  would  still  have  to  be  solved  as  to 
whether  such  original  cost  is  the  same  as  the  present  value." 
This  would  "involve  the  determination  of  the  present 
value  for  such  comparison  independent  of  original  cost,  and 
in  no  other  or  better  way  than  on  reproduction  value."*  It 
was  sufficient  for  the  Master  in  the  Minnesota  Rate  Cases 
that  the  public,  rather  than  dispense  with  the  service  of  any 
of  the  roads  concerned,  could  well  afford  to  pay  such  rates 
as  would  "produce  a  full  and  fair  return  on  their  cost  of 
reproduction."  Indeed,  the  public  would  gladly  pay  such 
rates,  since  abandonment  would  be  a  great  "calamity." 
If  the  roads  were  "suddenly  obliterated,  their  immediate 
reconstruction  would  follow  in  response  to  the  public 
necessity."  This,  to  his  mind,  demonstrated  that  the  roads 
"must  be  worth  what  it  would  cost  to  reproduce  them," 
and  that  a  return  on  such  cost  would  not  be  "oppressive."  4 

1  Knoxville  v.  Knoxville  Water  Co.,  212  U.S.  1.  9;  Minnesota  Rate 
Cases,  230  U.S.  352,  452. 

2  Judge  Hough  therefore  accepted  a  "cost  of  reproduction  less  de- 
preciation" estimate  of  one  of  the  company  experts.  See  Record,  Will- 
cox  v.  Consolidated  Gas  Co.,  212  U.S.  19,  Master's  Report,  page  170; 
testimony,  page  1313;  also  Consolidated  Gas  Co.  v.  New  York,  157  Fed. 
849,  855.  The  italics  are  the  writer's. 

*  L.  &  N.  R.R.  v.  R.R.  Commission  of  Alabama,  196  Fed.  800,  820. 
The  Court  regarded  "the  reproduction  cost  as  the  final  test  of  present 
value"  (page  821).  See  Western  Railway  of  Alabama  v.  R.R.  Commission 
of  Alabama,  197  Fed.  954,  961;  Cumberland  T.  &  T.  Co.  v.  City  of 
Louisville,  187  Fed.  637,  642;  State  Journal  Printing  Co.  v.  Madison 
G.  &  E.  Co.,  4  W.R.C.R.  501,  579. 

4  Report  of  Chas.  E.  Otis,  page  244.  Mr.  Otis  here  developed  an  origi- 
nal line  of  argument.  His  authority  for  the  choice  of  "cost  of  reproduc- 
tion" was  B.  H.  Meyer,  now  of  the  I.C.C.,  who  contributed  to  Bulletin 
21,  Bureau  of  the  Census,  on  Commercial  Valuation  of  Railway  Operating 
Property,  pages  19  and  51.  Mr.  Otis  spoke  of  an  "undepreciated  value." 


100  RAILROAD   VALUATION 

Thus  "cost  of  reproduction,"  though  ostensibly  but  a 
means  toward  an  end,  —  the  determination  of  "fair  value," 
—  has  become  confused  with  the  end  itself.  The  hypothesis, 
once  adopted,  has  been  applied  with  relentless  consistency. 
The  Master  in  the  Minnesota  Cases  included  bridges  over 
the  Minneapolis  &  St.  Louis  tracks  in  Minneapolis,  be- 
cause, though  built  by  the  city,  "  their  repair  and  renewal 
must  be  borne  by  the  company,  and  the  city  could  not  have 
been  compelled  to  construct  them  if  the  law  had  been 
properly  interpreted  and  observed."  1  The  land  "multi- 
ple" and  the  conjuring  up  of  unbuilt  structures  have  al- 
ready been  discussed.2  Mr.  J.  F.  Stevens,  to  whom  a  price 
of  $1.25  a  cubic  yard  for  excavating  solid  rock  seemed 
"at  first  glance  ...  to  be  high,"  was  reconciled  to  the 
price  when  he  "found  that  a  very  large  part  of  the 
440,000  yards  was  located  in  the  city  of  Minneapolis," 
where  "it  couldn't  be  done  for  any  reasonable  price."  3 
Or,  to  take  an  illustration  from  .the  New  York  Gas  Case, 
there  is  the  imaginary  expense  of  tearing  up  and  replacing 
the  street  pavement,  even  though  the  present  pavement 
was  laid  long  after  the  pipes  had  been  put  in  place,  etc.4 

Mr.  Meyer  was,  however,  discussing  "valuation,"  and  the  division  of 
"value"  between  the  States,  for  taxation  purposes.  Even  here  his  argu- 
ment hardly  seems  entirely  convincing. 

1  Report  of  Chas.  E.  Otis,  page  231. 

2  Above,  pages  33-37.  See  the  New  Haven  Validation  Report,  page  88, 
on  road  crossings  paid  for  in  part  by  the  Commonwealth. 

8  Minnesota  Rate  Cases,  Record  (G.N.),  page  430. 

4  See  cases  cited  and  discussed  in  Whitten,  Valuation  of  Public  Serv- 
ice Corporations,  pages  148-60;  970-89;  and  R.  E.  Heilman,  "Principles 
of  Public  Utility  Valuation,"  Quarterly  Journal  of  Economics,  volume  28, 
page  279. 

The  Master  in  the  New  York  Gas  Case,  Report,  page  177,  Willcox  p. 
Consolidated  Gas  Co.  (212  U.S.  19),  and  the  lower  Court  (157  Fed. 
849,  855)  both  included  in  "fair  value,"  not  only  this  "cost"  of  pave- 
ment, but  also  the  extra  "cost"  due  to  the  fact  that  the  subsurface  of 
the  street  was  now  more  crowded  than  when  the  mains  were  laid,  and 
that  a  more  expensive  engineering  task  was  presented. 

"The  value  of  the  investment  of  any  manufacturer  in  plant,  factory, 
or  goods,  or  all  three,  is  what  his  possessions  would  sell  for  upon  a  fair 


PHYSICAL  VALUATION  101 

The  Chief  Engineer  of  the  Washington  Commission 
omitted  the  cost  of  exploring  surveys,  which  had  cost  the 
Northern  Pacific  some  $300,000,  because,  in  the  event  of 
reproduction,'  such  "elaborate  exploration"  would  not  be 
needed.  The  best  route  was  known.1  But  in  no  case  has 
the  possibility  been  faced  that  were  a  road  "instantane- 
ously obliterated,"  grants  of  right  of  way  and  donations  of 
terminals  might  again  be  made  by  communities  so  sud- 
denly deprived  of  their  transportation  facilities. 

Emphasis  upon  "replacement  value"  has  furthermore 
been  to  the  advantage  of  the  local  public  utility  com- 
panies (and  probably,  also,  to  that  of  the  railroads)  be- 
cause of  the  present  high  level  of  prices  and  wages.  The 
fact  that  the  company  in  the  San  Diego  Water  Cases 
pleaded  for  actual  cost  as  a  legitimate  basis  —  the  plant 
having  been  built  at  boom  prices  —  suggests  that  had  the 
interest  of  the  companies  prompted  gathering  cost  figures, 
the  hopelessness  of  the  task  might  have  appeared  less 
appalling.  But  the  rise  in  construction  costs  has  simply 
made  possible  a  claim  of  another  "unearned  increment."  2 

transfer  from  a  willing  vendor  to  a  willing  buyer,  and  it  can  make  no 
difference  that  such  value  is  affected  by  the  efforts  of  himself,  or  others, 
by  whim  or  fashion,  or  (what  is  really  the  same  thing)  by  the  advance  of 
land  value  in  the  opinion  of  the  buying  public.  It  is  equally  immaterial 
that  such  value  is  affected  by  difficulties  of  reproduction.  If  it  be  true 
that  a  pipe  line  under  the  New  York  of  1907  is  worth  more  than  a  pipe 
line  under  the  city  of  1827,  then  the  owner  thereof  owns  that  value, 
and  that  such  advance  arose  from  difficulties  of  duplication  created  by 
the  city  itself  is  a  matter  of  no  moment."  To  the  Court  "investment" 
became  meaningless  if  construed  to  mean  what  the  thing  invested  in  cost 
generations  ago.  157  Fed.  849,  855.  (The  italics  are  the  writer's.) 

1  Second  and  Third  Annual  Reports,  Railroad  Commission  of  Wash- 
ington, pages  42-43. 

2  In  Steenerson  v.  Great  Northern  Ry.  Co.,  72  Northwestern  713,  715, 
decided  in  1897  when  the  level  of  prices  was  lower  than  when  the  roads 
had  been  built,  the  railroad  did  plead  for  a  "valuation"  on  the  basis  of 
cost.  The  Minnesota  Supreme  Court,  however,  used  cost  of  reproduction: 
"If  a  railroad  was  built  thirty  years  ago  at  a  cost  of  $40,000  per  mile, 
and  another  one  equally  as  good  was  built  within  a  year  through  the 
same  territory  at  a  cost  of  $12,000  per  mile,  on  what  principle  should  it 
be  held  that  the  old  road  was  entitled  to  3^  times  as  much  income  as  the 


10*  RAILBOAD  VALUATION 

To  what  extent  there  has  been  a  conscious  understanding 
of  this  element  of  self-interest  must  necessarily  be  difficult 
to  say.  Certainly  the  witnesses  for  the  railroads  in  the 
Minnesota  Rate  Cases  were  not  blind  to  the  circumstance 
that  the  unit  prices  used  were  in  many  cases  considerably 
above  the  amounts  actually  expended,  even  in  the  face  of 
important  technical  improvements.1 

But  it  was  in  terms  of  the  investment  (i.e.,  actual  cost) 
that  the  calculations  of  the  enterpriser  and  investor  were 
made.2  Of  this  amount,  no  inconsiderable  portion  was 

new  road?  No  guaranty  was  ever  made  by  the  State  to  the  old  road  that 
the  price  of  materials  and  the  cost  of  construction  would  not  decline, 
or  that  capital  invested  in  railroads  should  not  be  subject  to  like  vicissi- 
tudes as  capital  invested  in  other  enterprises.  Modern  improvements 
and  other  causes  have  continued  to  reduce  the  cost  of  construction  of  all 
kinds  of  new  plants,  and  to  reduce  the  value  of  old  plants  or  to  render 
them  wholly  worthless,  and  the  State  did  not  guaranty  that  those  causes 
should  not  in  like  manner  affect  the  capital  invested  in  railroads.  Then 
the  material  question  is  not  what  the  railroad  cost  originally,  but  what 
it  would  now  cost  to  reproduce  it." 

But  in  the  Minnesota  Rate  Cases,  the  State's  attorneys  talked  "cost"; 
the  Great  Northern  attorneys,  "reproduction." 

1  J.  F.  Stevens,  Record  (G.N.),  page  498  and  following;  W.  L.  Dar- 
ling, Record  (N.P.),  page  117. 

Nevertheless,  such  claims  have  been  specifically  upheld.  For  example, 
the  South  Dakota  Board  of  Railroad  Commissioners  has  said:  "The 
railway  company  is  entitled  to  any  increase  ...  in  the  price  of  rails,  ties, 
or  other  physical  item."  Twenty-First  Annual  Report,  page  28.  In 
Pioneer  Telephone  and  Telegraph  Co.  v.  Westenhaver,  the  Oklahoma 
Supreme  Court  expressed  itself  as  follows:  "Where  the  market  price 
of  the  physical  units  or  of  the  labor  entering  into  the  construction  of  the 
plant  has  advanced  since  its  construction,  the  original  cost  must  be 
much  lower  than  the  present  value;  and  for  that  reason  be  to  the  owner 
of  the  plant  an  unfair  determination  of  its  present  value."  118  Pacific 
854,  356. 

2  The  language  of  Justice  Field  in  the  Railroad  Commission  Cases, 
where  he,  with  Justice  Harlan,  dissented,  and  condemned  the  "value" 
test  as  set  up  in  the  Mississippi  statute  before  the  Court,  is  here  inter- 
esting, as  showing  that  an  entirely  different  line  of  reasoning  might  have 
been  subsequently  developed  by  a  different  set  of  facts  governing  the 
cases,  from  those  which  came  to  the  Court  in  the  California  Water  Cases. 
(Above,  page  8  and  note  3,  page  15.) 

"It  was  certainly  the  expectation  of  the  constructors  of  the  road  that 


PHYSICAL  VALUATION  103 

sunk,  once  for  all.  The  grade,  the  tunnels,  the  concrete 
abutments  and  retaining  walls,  etc.,  can  never  be  used 
except  in  the  place  where  originally  built.  The  result  of 
this  initial  investment  (in  the  great  multitude  of  cases  a 
permanent  investment)  is  the  large  importance  of  the 
element  of  the  return  to  investors  in  the  cost  of  transporta- 
tion. For  the  moment,  this  element  may  be  ignored,  since 
it  is  advantageous  to  operate  the  railroad  which  is  built, 
even  though  less  than  the  return  necessary  to  tempt 
investment  is  secured.  But,  in  the  long  run,  the  reward  for 
investing,  assuming  risk,  directing  enterprise,  must  be  met 
in  the  case  of  the  railroad  which  could  justify  the  building. 
Not  less  than  this  return  can  be  "  reasonable  "  where  rail- 
road enterprise  is  left  to  private  initiative.  Analyzing  the 
problem  in  this  light,  is  the  "cost  of  reproduction"  a 
logical  basis  by  which  to  measure  the  "long  run,"  —  the 
"reasonable"  return? 
On  the  contrary,  to  use  a  figure  of  "cost  of  reproduc- 

they  should  be  allowed  to  receive  compensation  having  some  relation  to 
its  cost.  But  the  act  of  Mississippi  allows  only  such  compensation  as 
parties  appointed  by  the  legislature,  not  interested  in  the  property,  or 
required  to  possess  any  knowledge  of  the  intricacies  and  difficulties  of  the 
business,  shall  determine  to  be  a  fair  return  on  the  value  of  the  road  and 
its  appurtenances,  though  tljat  may  be  much  less  than  the  original  cost. 
Within  the  last  few  years,  such  have  been  the  improvements  in  machin- 
ery, and  such  the  decline  in  the  cost  of  materials,  that  it  is  probably  less 
expensive  by  one  third  to  build  and  equip  the  road  than  it  was  when  the 
constructors  completed  it.  Does  anybody  believe  that  they  would  have 
undertaken  the  work  or  proceeded  with  it,  had  they  been  informed  that 
notwithstanding  their  vast  outlays,  they  should  only  be  allowed,  when  it 
was  finished,  to  receive  a  fair  return  upon  its  value,  however  much  less 
than  cost  that  might  be?"  116  U.S.  307,  343.  Justice  Field -very  evi- 
dently thought  of  "value"  in  terms  of  "cost  of  reproduction." 

Justice  Harlan  said  to  the  same  effect:  "Does  any  one  believe  that 
private  capitalists  would  have  supplied  the  money  necessary  to  establish 
and  maintain  these  enterprises  had  the  charters  contained  a  provision 
making  rates  depend  .  . .  not  on  the  amounts  expended  in  constructing 
and  maintaining  these  roads,  but  on  their  value?"  Ibid.,  page  340.  In 
Covington  &  Lexington  Turnpike  Co.  v.  Sandford,  Justice  Harlan  re- 
ferred to  "  the  amount  that  may  have  been  really  and  necessarily  invested 
in  the  enterprise."  164  U.S.  578,  597. 


104  RAILROAD  VALUATION 

tion"  is  to  introduce  into  the  standard  of  measurement  a 
factor  quite  divorced  from  the  business  of  furnishing  trans- 
portation —  the  effect  of  a  shifting  level  of  prices  and  wages. 
Here  is  a  place  where  the  justice  of  the  "give-and-take** 
argument  can  be  fairly  tested.  If  the  drop  in  the  level  of 
prices  seen  through  the  early  nineties  had  continued,  would 
it  have  represented  justice  to  investors  to  insist  that  their 
plants  were  "depreciating,"  solely  because  the  "cost  of 
reproduction*'  was  falling?  No.  Nor,  because  the  reverse 
tendency  has  appeared,  should  an  "appreciation**  be  recog- 
nized.1 The  conclusion  is  inevitable  that  attorneys  in 
directing  rate  cases  have  been  more  intent  upon  uncertain 
precedents  and  "rules'*  than  upon  securing  a  valid  answer 
to  the  problem  hi  the  solution  of  which  their  efforts  were 
presumably  being  directed. 

Certainly  were  "cost  of  reproduction"  to  be  accepted  as 
a  settled  test  there  would  be  no  such  thing  as  stability  in 
rates.  How  often  should  adjustment  be  made?  If  every 
year,  why  not  every  month?  Surely  the  figures  must  be 
fixed  at  regular  periods  to  conform  to  changes  in  costs. 
"It  is  commonly  assumed,"  says  one  writer,  "that  once  a 
valuation  has  been  made,  it  can  be  kept  up  to  date  and 

1  A  conclusion  similar  to  that  here  made  is  found  in  the  opinion  of 
Judge  Van  Fleet,  of  the  California  Supreme  Court  in  San  Diego  Water 
Co.  ».  San  Diego: 

"  It  would  ...  be  highly  unjust  to  permit  the  consumers  to  avail  them- 
selves of  the  plea  that  at  the  present  time,  similar  works  could  be  con- 
structed at  a  less  cost  as  a  pretext  for  reducing  the  rates.  .  .  .  Nor  would 
it,  on  the  other  hand,  be  just  to  the  consumers  to  require  them  to  pay  an 
enhanced  price  for  the  water,  on  the  ground  that  it  would  cost  more  now 
to  reconstruct  similar  works.  Such  a  contingency  may  well  happen,  but  to 
allow  an  increase  of  rates  for  such  reason  would  be  to  allow  the  water  com- 
pany to  make  a  profit,  not  as  a  reward  for  its  expenditures  and  service, 
but  for  the  fortuitous  occurrence  of  a  rise  in  the  price  of  materials  or 
labor.  The  law  does  not  intend  that  this  business  shall  be  a  speculation  in 
which  the  water  company  or  the  consumers  shall  respectively  win  or  lose 
upon  the  castings  of  a  die,  or  upon  the  equally  unpredictable  fluctuations 
of  the  markets.  For  the  money  which  the  company  has  expended  for  the 
public  benefit,  it  is  to  receive  a  reasonable  reward."  Three  of  seven  mem- 
bers of  the  Court  dissented  from  the  conclusion.  50  Pacific  633,  636. 


PHYSICAL  VALUATION  105 

available  for  rate  cases  merely  by  adding  to  it  from  time 
to  time  the  additional  investments  made  in  the  property. 
It  is  questionable  if  this  is  correct.  After  a  valuation  has 
been  made,  there  may  be  not  only  additional  investment, 
but  also  changes  in  the  unit  costs  of  labor  and  of  materials 
and  supplies,  in  the  value  of  land.  ...  It  would  seem 
therefore  that  if  valuation  is  to  be  used  for  the  regulation 
of  rates,  there  must  be  complete  revaluations  from  time 
to  time."  1  Indeed  the  total  secured  by  adding  the  cost  of 
betterments  to  the  "cost  of  reproduction"  estimate  would 
be  devoid  of  real  significance.  Either  "cost  of  reproduc- 
tion" must  be  rejected,  or  periodic  "revaluations"  must 
be  made;  unless  there  be  resignation  to  the  use  of  a  stand- 
ard which  measures  neither  cost  nor  "cost  of  reproduc- 
tion." Only  if  the  "valuation"  purports  to  establish  the 
amount  of  the  unimpaired  investment,  the  cost  of  the  units 
in  place,  with  deduction  to  measure  accrued  depreciation, 
can  the  subsequent  figures  of  cost  be  added.  Otherwise 
there  is  only  a  heterogeneous  combination  of  totals  made 
on  two  distinct  hypotheses.2 

1  S.  O.  Dunn,  "The  Valuation  of  Railways,"  Atlantic  Monthly,  volume 
113,  page  413.   See  T.  S.  Adams, "  Valuation  of  Railway  Properties,"  etc., 
Journal  of  Political  Economy,  volume  23,  page  16.   In  Mr.  Dunn's  argu- 
ment "value"  and  "cost  of  reproduction"  appear  as  practically  equiva- 
lent terms.    See  also  his  American  Transportation  Question,  chapters  5 
and  6. 

The  following,  from  Director  of  Valuation  Prouty's  address  before  the 
1914  Meeting  of  the  National  Association  of  Railway  Commissioners,  is 
also  pertinent: 

"  Prices  will  change.  Theories  of  valuation  will  change;  but  if  you  once 
have  the  quantities  which  enter  into  this  inventory  substantially  agreed 
upon  between  the  railroads  and  the  people,  you  have  there  a  basis  of  cal- 
culation to  which  you  can  subsequently  apply  different  prices  and  differ- 
ent theories."  Proceedings,  26th  Annual  Meeting,  page  135. 

2  Yet  it  would  seem  that  enthusiasm  over  the  possibilities  of  "valua- 
tion" led  even  so  keen  a  critic  as  Henry  C.  Adams  to  pass  over  an  incon- 
gruity which  is  readily  made  apparent,  when  analyzed  in  these  terms.  And 
on  this  account,  it  is  not  surprising  that  the  Commission  should  be  found 
to  have  followed  the  promptings  of  its  Statistician.    See  Mr.  Adams' 
letter  to  former  Chairman  Knapp,  dated  May  24,  1906,  quoted,  Senate 
Report  on  Valuation,  page  218,  citing  at  length  the  Michigan  Appraisal; 


106  RAILROAD  VALUATION 

But  what  of  the  courts?  Has  it  not  been  reiterated  that 
"  the  thing  to  be  ascertained  is  the  value  of  the  property  at 
the  time  it  is  being  used  for  the  public  service"?  1  Did  not 
Justice  Hughes  declare  that  the  property  is  held  in  private 
ownership,  and  that  it  is  "that  property  and  not  the  original 
cost  of  it,  of  which  the  owner  may  not  be  deprived"?  2 
Can  an  "unimpaired  investment"  standard  be  reconciled 
with  the  doctrine  of  the  courts?  So  long  as  assertion  is 
made  that  "value"  is  not  a  matter  of  formulas,  that  a 
series  of  unrelated  items  must  be  considered  in  making  a 
"reasonable  judgment,"  etc.,  a  valuation  theory  based 
upon  economic  principles  is  out  of  the  question.  The 
"unimpaired  investment"  standard  is  simply  a  reasoned 
attempt  to  meet  the  conditions  implied  by  the  following 
language  of  the  Court  in  Knoxville  v.  Knoxville  Water 
Company: 

"The  company  ...  is  entitled  to  see  that  from  the  earnings 
the  value  of  the  property  invested  is  kept  unimpaired,  so 
that  at  the  end  of  any  given  terms  of  years,  the  original 
investment  remains  as  it  was  in  the  beginning.  It  is  not 
only  the  right  of  the  company  to  make  such  a  provision, 
but  it  is  its  duty  to  its  bond  and  stockholders,  and  in  the 
case  of  a  public  utility  corporation,  at  least,  its  plain  duty 
to  the  public."  3 

So,  if  the  investment  represents  stored-up  "value,"  un- 
impaired investment  —  the  cost  of  the  existing  units  minus 
accrued  depreciation  measured  in  dollars  —  represents,  in 
a  very  real  sense,  "present  value."  From  this  viewpoint, 
the  discussion  does  indicate  the  way  to  a  possible  recon- 
ciliation with  the  judicial  dicta. 

and  his  report  to  the  Commission,  Statistics  of  Railways,  1907,  pages 
147-48.  See  also  Annual  Report,  Interstate  Commerce  Commission,  1910, 
page  37. 

1  The  Valuation  Brief  of  1915,  page  469. 

2  Minnesota  Rate  Cases,  230  U.S.  352,454.  It  would  be  useless  to  at- 
tempt an  exact  interpretation  of  this  sentence.  In  regulation  there  is  no 
question  of  "taking";  a  measure  of  income  is  sought. 

*  212  U.S.  1,  13. 


PHYSICAL  VALUATION  107 

But  the  verdict  for  unimpaired  investment  —  a  cost 
standard  —  does  not  mean  that  where  "  the  money 
actually  paid  into  a  railway  property  represents  all 
manner  of  waste  and  extravagance,  the  public  ought  to 
pay  on  this."  l  The  argument  that  an  investment  test  (in 
terms  of  actual  cost)  would  of  necessity  imply  a  guarantee 
(or  its  equivalent)  upon  unwise  or  dishonest  expenditure 
fails  to  take  account  of  the  character  of  the  rate  of  return  as 
a  variable.2  Discrimination  is  necessary  in  the  exceptional 
case  in  any  event.  No  guarantee  has  been  made  by  the 
public.  None  is  implied.  Where  there  are  successful  enter- 
prises, there  may  also  be  failures. 

1  In  the  Matter  of  Advances  (1903),  9  I.C.C.  382,  403. 

2  "If  a  plant  is  built,  as  probably  this  was,  for  a  larger  area  than  it 
finds  itself  able  to  supply,  or,  apart  from  that,  if  it  does  not,  as  yet,  have 
the  customers  contemplated,  neither  justice  nor  the  Constitution  re- 
quires that,  say,  two  thirds  of  the  contemplated  number  should  pay  a  full 
return.  ...  If  the  original  company  embarked  upon  a  speculation  which 
has  not  turned  out  as  expected,  more  modest  valuations  are  a  result  to  which 
it  must  make  up  its  mind."  Justice  Holmes,  San  Diego  L.  &  T.  Co.  v. 
Jasper,  189  U.S.  439,  446.    The  italics  are  the  writer's. 

To  the  same  effect,  see  Stanislaus  County  v.  San  Joaquin  and  Kings 
River  C.  &  I.  Co.,  192  U.S.  201,  214.  A  peculiar  twist  was  given  the  rea- 
soning by  the  fact  that  these  cases  concerned  a  statute  which  provided 
that  6  to  18  per  cent  should  be  allowed  on  the  "value"  of  the  property. 


CHAPTER  V 

PHYSICAL  VALUATION  —  UNIMPAIRED  INVESTMENT 

Introduction:  Maintenance  of  the  investment,  108. 

I.  Investment  and  the  creation  of  capital  goods,  110. 

Depreciation  and  replacement,  110.  —  "Maintenance"  as  the 
creation  of  capital  goods,  111.  —  Charging  plant  to  operating 
expense,  114.  —  The  surplus,  115. 
II.  Depreciation  as  an  operating  cost,  117. 

The  depreciation  reserve  not  a  fund  for  replacements,  117.  — 
The  permanent  depreciation  reserve,  119.  —  Deduction  for  accrued 
depreciation,  120.  —  Innocent  holders  and  vested  interests,  121. 
—  The  "simple"  and  "composite"  property  theory,  122. 

III.  Land,  the  indestructible  element,  124. 

Original  cost,  and  the  "unearned  increment,"  125.  —  The  Su- 
preme Court  opinions,  126. — The  alienation  argument,  129. — The 
discrimination  argument,  130.  —  Unearned  income  essential  for  an 
"unearned  increment,"  130. 

IV.  Appraisal  of  unimpaired  investment,  135. 

Depreciated  cost  of  the  units  in  place,  136.  —  Experience  of  the 
Interstate  Commerce  Commission,  136.  —  Inability  to  measure 
unimpaired  investment  not  a  reason  to  use  "cost  of  reproduc- 
tion," 138.  —  Possible  usefulness  of  the  Federal  Valuation  chal- 
lenged, 139. 

"PROPERTY  INVESTMENT,"  the  first  item  on  the  assets 
side  of  the  railroad  balance  sheet,  purports  to  indicate  the 
amount  of  the  investment  which  the  railroad  devotes  to 
the  public  service.  That  the  account  is  quite  devoid  of  such 
significance  is  a  matter  of  common  knowledge.  Too  often, 
as  originally  set  up,  it  has  been  hardly  more  than  the 
journal  entry  necessary  to  balance  the  par  value  of 
securities.  Even  had  the  first  figures  been  substantially 
accurate,  conservative  management,  preferring  to  err  on 
the  side  of  safety,  if  at  all,  has  swelled  the  actual  invest- 
ment through  charges  of  net  additions  to  operating  ex- 
pense. Or  less  efficient  management,  perhaps  less  honest 
management,  or  even  less  fortunate  management,  has  per- 


UNIMPAIRED  INVESTMENT  109 

mitted  the  original  plant  to  wear  out,  without  changing 
the  accounts. 

Maintenance  of  the  investment  means  something  other 
than  maintenance  in  a  state  of  working  efficiency.  It  has 
reference  to  a  standard  measured  in  dollars.  That  a  five- 
year-old  box  car  in  good  repair  will  earn  as  much  per  mile 
as  a  perfectly  new  box  car  of  the  same  type  is  beside  the 
point.1  As  between  the  five-year-old  car  and  the  one 
"perfectly  new,"  there  is  this  significant  difference  of 
position:  if  the  life  of  such  a  car  be  twenty  years  "on  the 
average,"  twenty-five  per  cent  of  the  life  is  spent  in  the  one 
case;  nothing  at  all  in  the  other.  Unless,  during  this  five 
years,  earnings  have  been  put  back  into  the  plant  equal  to 
the  volume  of  income  representing  the  using-up  of  the  car, 
the  investment  has  by  so  much  been  impaired.  If  the  car 
were  to  be  scrapped  at  the  end  of  this  fifth  year,  there 
would  be  no  hesitation  in  recognizing  that  the  investment 
was  entirely  gone.  The  principle  is  the  same  (though  the 
task  of  measurement  be  difficult)  when  the  item  of  plant  is 
still  in  working  condition,  but  with  a  shortened  expec- 
tation of  life.2  The  question  always  is:  How  much  un- 
impaired investment — "unripened  savings"  —  does  the 
plant  represent? 

1  J.  F.  Stevens,  Minnesota  Rate  Cases,  Record  (G.N.),  page  551; 
see  testimony  of  J.  J.  Hill,  ibid.,  page  1330  and  following.  Typical  of  this 
point  of  view  (not  unusual  with  railroad  men)  are  three  articles  by 
Wm.  Mahl,  Railroad  Gazette,  volume  43,  page  418;  Railway  Age  Gazette, 
volume  48,  pages  440,  1249.  Two  prominent  engineers,  speaking  at  the 
annual  meeting  of  the  American  Society  of  Civil  Engineers,  indicated 
their  acceptance  of  a  similar  argument:  W.  J.  Wilgus,  Proceedings,  Am. 
Soc.,  C.E.,  volume  40,  page  366;  G.  F.  Swain,  ibid.,  page  1413  and 
following.   Mr.  Swain  took  the  same  stand  in  his  New  Haven  Validation 
Report,  page  59  and  following. 

2  See  Allyn  A.  Young,  "Depreciation  and  Rate  Control,"  Quarterly 
Journal  of  Economics,  volume  28,  pages  634-35,  for  what  seems  to  be 
a  contrary  point  of  view;  and  especially  the  answer  by  J.  S.  Davis,  ibid.t 
volume  29,  page  362.    The  discussion  was  continued  in  the  same  journal 
by  John  Bauer,  volume  29,  page  651,  and  by  J.  C.  Bonbright,  volume  30, 
page  546. 


110  RAILROAD  VALUATION 


An  appraisal  on  the  basis  of  the  cost  of  the  units  in  place, 
with  deduction  to  take  account  of  accrued  depreciation, 
seeks  to  determine  what  has  in  fact  taken  place.  Un- 
impaired investment  measured  in  this  manner  can  co- 
incide with  "cost"  as  determined  from  reference  to  the 
amount  of  the  contributions  made  by  security-holders  to 
the  company  treasury,  only  if  the  management  previous 
to  the  appraisal  has  been  successful  in  maintaining  the 
"investment"  at  exactly  the  original  level  —  the  cost  of 
improvements,  etc.,  balancing  the  accrued  depreciation, 
in  terms  of  dollars.  If  the  level  of  investment  has  not  been 
kept  up,  or  if  net  additions  have  been  charged  to  operating 
expenses,  there  can  be  no  such  coincidence.  The  result  of 
an  appraisal  (assuming  accuracy  possible)  would  indicate 
which  had  actually  occurred. 

Where,  as  railroad  men  seem  so  unanimous  in  their 
belief,  "maintenance"  has  resulted  in  widening  the  grade, 
deepening  ditches,  etc.,  it  has  been  insisted,  even  with  the 
"cost  of  reproduction"  hypothesis,  that  a  creation  of 
"capital  goods,"  of  plant,  has  taken  place.  "A  railroad 
property  is  not  a  finished  product  when  the  construction 
forces  have  put  its  parts  together  and  turned  it  over  to  the 
operating  department.  Many  expenditures  are  still  re- 
quired to  be  made  in  resurfacing,  in  opening  up  clogged 
waterways,  and  in  bringing  about  an  improved  condition 
of  roadbed,  right  of  way,  and  station  grounds."  The  con- 
spicuous item  is  the  roadbed,  where  "solidification  and 
seasoning "  take  place,  "  under  the  action  of  the  elements, 
through  use  and  the  running  of  trains,  through  the  skillful 
direction  of  labor  in  checking  wastes  on  the  slopes  of  the 
embankments  and  encouraging  the  growth  of  vegetation 
thereon,  ditching  the  cuts,  and  kindred  work."  l  Signifi- 
cant, of  course,  is  the  expenditure  of  labor  in  correcting 
1  The  Valuation  Brief  of  1915,  pages  157-158. 


UNIMPAIRED  INVESTMENT  111 

the  first  wastes  due  to  the  elements,  and  in  improving  the 
physical  plant  as  lapse  of  time  develops  unforeseen  weak- 
ness. The  high  cost  of  maintenance  in  the  early  days  of 
operation  is,  in  no  small  measure,  due  to  the  fact  that  such 
expenditures  must  be  made.  But  the  "appreciation"  is 
not  due  to  the  fact  that  smaller  maintenance  charges  are 
later  necessary.  It  exists  because  amounts  charged  to 
operating  expense  have  resulted  in  a  net  addition  to  the 
"capital  goods"  of  the  railroad.1 

For  the  work  of  maintenance  is  always  a  creation  —  or  a 
"re-creation"  —  of  capital  goods,  though  the  accountant 
conceives  of  it  only  as  "expense."  And  the  reason  he  does 
not  recognize  that  the  maintenance  cost  represents  making 
of  plant  (not  in  toto  a  net  addition,  since  deduction  must 
first  be  made  to  cover  the  "depreciation"  which  the 
"maintenance"  seeks  in  part  to  overcome)  has  been  the 
difficulty  of  measuring  the  amount  of  the  depreciation;  as 
well,  perhaps,  as  the  general  insufficiency  of  practice.  Ad- 
herence to  the  accounting  categories  has,  it  would  seem, 
served  to  hide  the  facts  which,  from  the  point  of  view  of 
economic  theory,  are  most  significant. 

Take  the  case  of  the  locomotive.  When  it  has  been 
shopped,  the  cost  of  the  new  wheel,  or  piston  rod,  or  driv- 
ing axle  constitutes  the  existing  investment,  not  the  cost 

1  The  Valuation  Brief  of  1915  defines  "appreciation"  as  "in  every 
case,  an  increase  in  value  which  may  or  may  not  be  represented  by 
an  expenditure"  (page  146).  The  amount  of  such  uncertain  "appre- 
ciation" is  recognized  as  difficult  of  ascertainment  (pages  158, 161).  The 
methods  used  in  the  appraisals  to  measure  the  "appreciation"  of  the 
grade  have  been  the  usual  bulk  allowance  and  percentage  short  cuts. 

The  allowance  for  "impact  and  adaptation"  was  made  by  R.  P.  Mor- 
gan, in  his  Report  to  the  Pacific  Railway  Commission  (Senate  Executive 
Document  51,  50th  Congress,  1st  Session,  page  4454);  no  formal  allow- 
ance was  made  in  the  Michigan  or  Wisconsin  appraisals;  but  D.  C.  Mor- 
gan here,  as  in  many  other  details,  followed  the  precedent  set  by  his 
father;  Minnesota  Rate  Cases,  Record  (N.P.),  pages  1863,  2037;  see  tes- 
timony of  Howard  Elliott,  ibid.,  page  1250;  of  W.  L.  Darling,  ibid.,  page 
3227;  and  of  J.  F.  Stevens,  Record  (G.N.),  page  509;  and  Whitten, 
Valuation  of  Public  Service  Corporations,  chapter  xvi,  page  310. 


112  RAILROAD  VALUATION 

of  the  original  part  which  has  become  worn  out  and  useless 
for  productive  purposes.  The  Superintendent  of  Motive 
Power  of  the  Great  Northern  cited,  in  the  Minnesota  Rate 
Cases,  the  instance  of  an  engine,  purchased  "say  thirty- 
seven  years"  before,  which  was  still  in  service,  though  pos- 
sibly not  ten  per  cent  of  the  original  locomotive  remained 
intact.  "A  limit"  was  placed  "for  all  working  parts  —  all 
reciprocating,  revolving,  and  frictional  parts";  and  when 
the  parts  reached  "  this  certain  limit,"  they  were  renewed. 
"The  same  thing"  held  true  "in  connection  with  a  boiler," 
and  with  parts  of  cars.1  The  accountant  would  conceive 
of  the  cost  of  such  repairs  as  "maintenance,"  therefore 
solely  as  "operating  expenses." 2  Business  practice  does  not 
coincide  with  the  refinement  of  economic  theory,  which  is 
important  for  the  course  of  the  present  reasoning. 

Former  Commissioner  Maltbie,  of  New  York,  has  in- 
dicated his  adherence  to  a  position  opposed  to  that  here 
contended  for: 

"If  a  company  has  included  in  its  operating  expenses, 
items  which  it  now  asserts  are  part  of  its  capital  investment, 
it  is  in  error.  An  expenditure  cannot  be  an  operating  expense 
one  day  and  a  capital  charge  another  according  to  the  thesis 
which  the  company  at  that  moment  is  attempting  to  main- 
tain. Certainly  if  it  has  included  an  item  among  operating 
expenses,  it  is  incumbent  upon  the  company  to  show  wherein 
such  act  was  wrong,  and  why  the  Commission  should  in  any 
rate  case  be  compelled  to  allow  it  a  return  upon  property 
paid  for  out  of  operating  expenses.  .  .  ." 

Mr.  Maltbie  illustrated  his  meaning: 

"In  the  case  of  a  car  which  originally  did  not  have  air 
brakes,  but  has  been  equipped  with  modern  appliances,  cost 
to  date  means  the  original  cost  of  the  car  plus  the  cost  of  the 

1  G.  H.  Emerson,  Minnesota  Rate  Cases,  Record  (G.N.),  page  953. 

2  But  see  the  suggestive  diagrams,  in  F.  A.  Delano,  "The  Applica- 
tion of  a  Depreciation  Charge  in  Railway  Accounting,"  Journal  of  Politi- 
cal Economy,  volume  16,  page  585  and  following. 


UNIMPAIRED  INVESTMENT  113 

air  brakes;  but  it  does  not  include  the  cost  of  replacing  the 
old  equipment  with  new  equipment  of  the  same  character, 
or  of  new  equipment  slightly  different  in  form,  but  not  in- 
creasing the  carrying  capacity  or  durability  of  the  car." 

It  would  seem  that  this  language  fails  to  meet  the  im- 
portant issue.  Car  capacity,  efficiency,  etc.,  are  beside  the 
point.  Investment  —  unimpaired  investment  —  alone  is 
significant.  To  illustrate;  assume  that  a  car  costing  $800 
is  equipped  with  air  brakes  at  a  cost  of  $35.  Later  the  air 
brake  equipment  is  replaced  in  toto  at  a  cost  of  $60,  the 
extra  $25  being  charged  to  operating  expenses.  Mr. 
Maltbie  would  place  the  "cost  to  date"  at  $835;  the 
present  reasoning  (leaving  aside  the  question  of  deprecia- 
tion) would  set  the  investment  at  $860.  The  accounting 
practice  would  have  nothing  to  do  with  the  fundamental 
issue.1 

The  validity  of  the  present  contention  is  seen  most 
clearly,  perhaps,  when  the  old  property  has  been  totally 
destroyed.  An  excellent  illustration  is  afforded  by  the 
flood  damage  which  was  suffered  by  the  Ohio  and  Indiana 
lines  in  1913.  The  old  station  houses,  grade,  bridges, 
track,  etc.,  were  practically  wiped  out.  The  cost  of  the 
roadbed  and  structures  which  were  built  in  repairing  the 
damage  was  charged  to  operating  expense  in  that  year. 
But  the  accounting  practice  does  not  hide  the  fact  that  the 
cost  in  1913  —  the  cost  of  replacing  destroyed  units  — 
constitutes  the  investment  in  existing  plant,  subject  to 
changes  from  depreciation  and  "maintenance."  The  orig- 
inal roadbed  and  the  structures  built  thirty  or  fifty  years 
ago  were  destroyed  by  the  flood.  Their  cost,  therefore, 
has  nothing  whatever  to  do  with  the  existing  units  of 

1  This  discussion  is  based  upon  Mr.  Maltbie's  Report  to  the  National 
Association  of  Railway  Commissioners,  Proceedings,  26th  Annual  Meet- 
ing, page  183.  In  apparent  accord  with  him  are  John  H.  Gray,  "The 
Vagaries  of  Valuation,"  American  Economic  Review,  volume  4,  Supple- 
ment, page  32;  and  E.  W.  Bemis,  Proceedings,  National  Association  of 
Railway  Commissioners,  25th  Annual  Meeting,  page  318. 


114  RAILROAD   VALUATION 

railroad  plant.1  If  the  destruction  was  only  partial,  some 
units  of  the  original  plant  and  some  of  the  new  now  exist 
side  by  side.  Investment  has  been  made  at  separate 
dates. 

One  cannot  be  sure  that  the  Interstate  Commerce  Com- 
mission has  conclusively  disposed  of  the  policy  of  charging 
plant  to  operating  expense.  In  the  absence  of  depreciation 
charges,  or  when  charges  based  upon  an  expected  life  of 
fifty  to  a  hundred  years  have  been  made  on  equipment 
which  will  probably  last  less  than  thirty,2  the  fact  that  ex- 
tensions or  realignments  have  been  paid  for  out  of  earnings 
does  not  of  itself  prove  that  net  additions  to  investment 
have  been  made.  In  Central  Yellow  Pine  Association  v.  Illi- 
nois Central  Railroad  Company,3  an  advance  in  rates  was 
justified  by  the  carriers  on  the  plea  that  their  net  returns 
were  insufficient,  due  to  increased  cost  of  operation. 
Commissioner  Clements  found  that  considerable  sums 
spent  for  new  equipment  and  for  improvements  to  roadbed 
had  been  charged  to  operating  expenses.  These  items  were 
held  to  be  improperly  charged  in  this  manner,  since  "the 
shipper  of  to-day  could  not  be  properly  required  to  pay  the 
entire  cost  of  an  improvement  or  addition  which  was  to  be 
of  permanent  use."  4  Suit  was  brought  to  enforce  the  order 
of  the  Commission  that  the  roads  desist  from  making  the 
advance,  and  the  Supreme  Court  sustained  the  order.  "It 
would  seem,"  said  Justice  McKenna,  "as  if  expenditures 

1  The  unusually  high  "maintenance"  charges  due  to  flood  damage 
were  discussed  in  the  Five  Per  Cent  Case,  31  I.C.C.  350,  371. 

An  example  of  property  destroyed  in  war  times  (the  Atlanta  &  West 
Point),  and  subsequently  "rebuilt"  from  earnings,  was  cited  by  Commis- 
sioner Clements  in  his  testimony  before  the  House  Committee  on  Inter- 
state Commerce,  in  1912.  Senate  Report  on  Valuation,  page  206. 

2  See  St.  Paul  and  Puget  Sound  Accounts,  29  I.C.C.  508,  515. 
»  10  I.C.C.  505. 

4  Eastern  Advance  Case  of  1910, 20  I.C.C.  243, 265.  See  Cattle  Raisers' 
Association  v.  M.K.  &  T.  Ry.  Co.,  13  I.C.C.  418,  432;  Receivers  and 
Shippers  Association  v.  C.N.O.  &  T.P.  Ry.  Co.,  18  I.C.C.  440,  462. 


UNIMPAIRED  INVESTMENT  115 

for  additions  to  construction  and  equipment,  as  expendi- 
tures for  original  construction  and  equipment,  should  be 
reimbursed  by  all  the  traffic  they  accommodate  during  the 
period  of  their  duration,  and  that  improvements  that  will 
last  many  years  should  not  be  charged  against  the  revenues 
of  a  single  year."  1  This  argument  fails  to  recognize  that 
the  income  spent  for  fixed  improvement  may  be  that  which 
is  received  in  reimbursement  for  the  wearing  out  of  fixed 
capital  where  investment  has  been  made  in  the  past.  Un- 
less "  instrumentalities  which  are  to  be  used  for  years  "  are 
paid  for  "by  the  revenues  of  a  single  day  or  year,"  the 
investment  cannot  be  kept  intact.  The  same  principle  is 
involved  whether  replacement  in  kind  is  effected  or  addi- 
tional units  of  plant  are  added.  Both  represent  expendi- 
tures made  for  a  future  day.  But  it  is  only  if  the  amount  of 
the  maintenance  cost  in  any  one  year,  plus  the  amount 
spent  for  new  plant,  exceeds  the  accruing  depreciation  that 
there  is  any  net  addition  to  the  investment  in  plant.  The 
Commission  may  well  have  reached  a  correct  answer  in  the 
Central  Yellow  Pine  Case,  but  the  argument  used  to  justify 
that  answer  is  not  necessarily  convincing.  It  would  seem 
that  the  Commission  itself  forgot  that  maintenance  in  a 
state  of  efficiency  does  not  necessarily  signify  maintenance 
of  the  volume  of  investment  in  terms  of  dollars. 

The  possible  inadequacy  of  the  charges  to  operating 
expenses  where  no  depreciation  reserve  has  been  estab- 
lished, or  where  an  improbable  lifetime  has  been  assumed 
for  equipment,  directs  attention  to  the  railroad  "  surplus  " 
accounts.  If,  in  the  past,  net  earnings  have  been  actually 
overstated  through  failure  to  charge  the  amount  necessary 

1  Illinois  Central  R.R.  Co.  v.  I.C.C.,  206  U.S.  441,  462.  The  Commis- 
sion's holding  in  the  Central  Yellow  Pine  Case  and  the  Supreme  Court's 
approval  of  the  doctrine  are  the  basis  for  Commissioner  Prouty's  argu- 
ment refusing  to  permit  earnings  which  should  pay  for  the  "unpro- 
ductive improvements."  Eastern  Advance  Case  of  1910,  20  I.C.C.  243, 
265. 


116  RAILROAD  VALUATION 

to  take  account  of  the  depreciation  —  either  through  neg- 
lect or  maintenance,  or  failure  to  set  up  a  reserve,  or  both 
—  any  addition  to  surplus  in  that  year  has  by  so  much  been 
unreal.  On  the  other  hand,  when  net  additions  to  "in- 
vestment" have  been  made  through  charges  to  operating 
expenses  (in  substance,  where  a  "secret  reserve"  has  been 
created)  the  surplus  has  been  understated.  In  view  of  the 
haphazard  mode  of  handling  railroad  accounts,  therefore, 
the  fact  that  a  "surplus"  account  is  carried  on  the  books 
of  itself  signifies  nothing.1 

This  fact,  too,  it  would  seem,  the  Commission  has  over- 
looked. Neither  in  the  Spokane  Case,  nor  in  the  1910 
Advance  Cases,  was  challenge  directed  at  the  reality  of  the 
surplus.  The  nearest  approach  to  a  searching  criticism  is 
Commissioner  Lane's  assertion  that  the  surplus  depends 
"  upon  the  nature  of  a  railroad's  capitalization,  the  policy 
of  the  road  with  respect  to  charges  for  maintenance,  the 
volume  of  the  dividend,  and  other  factors  entirely  within 

1  Commissioner  Prouty,  discussing  the  railroad  claim  "that  there  is  an 
item  of  obsolescence  in  the  development  of  a  railroad  which  should  be 
recognized  in  the  surplus,"  approached  a  statement  of  this  problem,  but 
that  is  all.  He  assumed  the  case  of  the  building  of  a  railroad  over  a  moun- 
tain, "it  being  more  economical  to  haul  the  traffic  up  and  down  the  steep 
grades  than  to  incur  the  great  outlay  which  would  be  required  by  con- 
structing a  tunnel.  With  the  development  of  traffic  the  time  comes  when 
this  mountain  must  be  pierced,  and  a  tunnel  is  accordingly  constructed 
at  a  large  expenditure.  .  .  . 

"Now,  it  had  been  certain  from  the  day  of  the  original  construction 
of  that  railroad  that  in  time  the  tunnel  must  be  built.  Each  year  the  day 
drew  nearer  when  the  line  over  that  mountain  would  no  longer  be  used, 
and  therefore  each  year  subtracted  from  the  value  of  that  line.  It  may 
well  be  said  that  the  railroad  should  be  allowed  to  accumulate  a  fund 
out  of  its  revenues  from  operation  against  the  time  when  this  piece  of 
railroad  must  be  entirely  thrown  away.  Under  our  present  system  of  ac- 
counting railways  are  required  to  make  a  depreciation  charge  with  respect 
to  their  equipment  for  the  purpose  of  providing  against  contingencies  of 
this  sort;  but  they  make  no  such  charges  with  respect  to  their  way  and 
structures,  and  it  seems  proper  that  the  accumulation  of  a  surplus  should 
be  allowed  in  this  view."  The  Eastern  Advance  Case  of  1910,  20  I.C.C. 
243,  271.  See  testimony  of  President  Ripley  of  the  Santa  Fe,  Evidence, 
1910  Advances,  page  24. 


UNIMPAIRED  INVESTMENT  117 

the  directors'  control."  The  lines  of  inquiry  possibly  sug- 
gested by  these  topics  were  not  opened.1 


II 

Failure  to  understand  the  nature  of  the  depreciation 
reserve,  and  the  purpose  of  making  the  annual  charge  to 
depreciation,  has  led  to  further  confusion.  Depreciation  is 
a  necessary  operating  cost,  whether  or  not  it  is  given  formal 
recognition  in  the  accounts.  The  formal  allowance  simply 
seeks  to  insure  that,  when  any  unit  of  plant  is  retired,  its 
cost  shall  have  been  charged  against  the  expense  of  pro- 
ducing the  commodity  or  service  to  which  it  has  contributed 
during  its  working  lifetime.  In  this  sense,  necessity  for 
replacement  may  be  said  to  account  for  the  insistence  upon 
the  charge  to  depreciation.  "Capital  goods"  wear  out. 
But  the  reserve,  created  through  a  series  of  annual  charges 
as  plant  nears  the  day  of  scrapping,  and  the  investment 
"ripens"  into  product,  is  in  no  sense  of  the  word  a  "fund" 
for  the  provision  of  new  units  of  plant.2  The  total  accumu- 

1  The  Western  Advance  Case  of  1910,  20  I.C.C.  307, 332.  See  the  East- 
ern Case,  page  269,  summarizing  the  testimony  of  President  McCrea,  of 
the  Pennsylvania,  who  had  said  that  since  1887  the  amount  expended  on 
the  property  of  the  lines  east  of  Pittsburgh  out  of  surplus  earnings  and 
from  other  sources  than  the  proceeds  of  the  sale  of  securities  had  aggre- 
gated $262,000,000,  the  largest  amount  being  provided  by  surplus  earn- 
ings. Evidence,  1910  Advances,  page  2287;  also  page  2315;  see  testimony 
of  W.  C.  Brown,  of  the  New  York  Central  Lines,  page  2489;  of  Frank  Ward, 
of  the  C.B.  &  Q.,  page  1014;  and  of  M.  P.  Blauvelt,  of  the  Illinois  Cen- 
tral, pages  507,  530.  But  at  no  point  did  a  challenge  appear  to  indicate 
the  inconclusive  nature  of  this  testimony.    To  what  extent,  if  at  all,  does 
the  addition  of  property  costing  some  $262,000,000  represent  a  net  ad- 
dition to  investment  (not  to  physical  units  of  plant)?  —  That  is  the 
significant  point  for  the  economist.    But  this  difficulty,  the  Commission, 
and  its  attorney,  Mr.  Lyon,  did  not  consider.    See  Brief  of  the  latter, 
Evidence,  1910  Advances,  page  3527. 

2  In  Railroad  Commission  of  Louisiana  v.  Cumberland  T.  &  T.  Co., 
Justice  Peckham  apparently  failed  to  see  the  real  significance  of  the  de- 
preciation reserve.  In  the  lower  court  the  counsel  for  the  Louisiana  Com- 
mission had  argued  that  a  part  of  the  company's  plant  had  been  paid  for 
out  of  earnings,  "the  surplus  or  reserve  or  depreciation  fund,  which  was 


118  RAILROAD  VALUATION 

lation  at  any  one  time  (assuming  the  accounting  records  to 
measure,  with  all  practicable  accuracy,  the  real  economic 
facts)  measures  the  amount  by  which  the  investment  has 
been  used  up.  The  usual  practice  of  diminishing  the  reserve 
through  a  series  of  journal  entries,  as  new  units  of  equip- 
ment are  added,  does  not  mean  that  the  depreciation  re- 
serve is  established  in  order  to  provide  a  fund  for  replace- 
ments. That  many  accountants,  including  even  those  of 
the  Interstate  Commerce  Commission,  may  have  been 
guilty  of  this  confusion,  does  not  in  any  sense  alter  the 
fundamental  problem  of  economics.1 

accumulated  by  the  complainant  from  the  receipts  .  .  .  and  was  then  in- 
vested, not  in  repairs  and  maintenance,  but  in  extensions  and  property." 
To  this  theory  (which  looks  upon  the  depreciation  reserve  as  a  source  for 
repairs  and  maintenance,  and  not  as  a  measure  of  accrued  depreciation) 
Justice  Peckham  subscribed. 

"It  was  obligatory  upon  the  complainant,"  he  said,  in  reversing  the 
opinion  of  the  lower  court,  "  to  show  that  no  part  of  the  money  raised  to 
pay  for  depreciation  was  added  to  capital,  upon  which  a  return  was  to  be 
made  to  stockholders  in  the  way  of  dividends  for  the  future.  ...  It  cer- 
tainly was  not  proper  for  the  complainant  to  take  the  money,  or  any 
portion  of  it,  which  it  received  as  a  result  of  the  rates  under  which  it 
was  operating,  and  so  to  use  it,  or  any  part  of  it,  as  to  permit  the  com- 
pany to  add  it  to  its  capital  account,  upon  which  it  was  paying  dividends 
to  shareholders.  If  that  were  allowable,  it  would  be  collecting  money  to 
pay  for  depreciation  of  the  property  and,  having  collected  it,  to  use  it 
in  another  way,  upon  which  the  complainant  would  obtain  a  return  and 
distribute  it  to  its  stockholders.  That  it  was  right  to  raise  more  money 
to  pay  for  depreciation  than  was  actually  disbursed  for  the  particular 
year  there  can  be  no  doubt,  for  a  reserve  is  necessary  in  any  business  of 
this  kind,  and  so  it  might  accumulate;  but  to  raise  more  than  money 
enough  for  the  purpose,  and  place  the  balance  to  the  credit  of  capital 
upon  which  to  pay  dividends,  cannot  be  proper  treatment."  212  U.S.  414, 
424.  For  similarly  uncertain  language,  see  quotations  from  cases  given  in 
the  Valuation  Brief  of  1915,  pages  167-88. 

The  elusive  character  of  the  depreciation  reserve,  as  contrasted  with 
the  depreciation  fund,  has  also,  as  it  seems  to  the  writer,  deceived  J.  E. 
Allison,  Should  Public  Service  Properties  be  Depreciated?  etc.,  though  Mr. 
Allison's  conclusions  are  diametrically  opposed  to  those  of  Justice  Peck- 
ham  (pages  17,  26). 

1  For  what  seems  to  be  a  contrary  conclusion,  see  Professor  Young's 
"Concluding  Comments"  on  Dr.  Davis*  criticism  of  Professor  Young's 
article  in  the  Quarterly  Journal  of  Economics,  volume  28,  page  630;  vol- 


UNIMPAIRED  INVESTMENT  119 

As  a  matter  of  fact,  in  a  business  possessing  a  large  and 
varied  plant,  the  "depreciation  reserve"  is  usually  perma- 
nent. The  plant  is  maintained  in  a  state  of  "average 
depreciation."  Some  writers,  looking  upon  this  phenom- 
enon alone,  as  it  would  seem,  and  thinking  of  the  cause 
of  establishing  the  reserve  as  the  creation  of  a  source  of 
replacements,  and  not  as  a  measure  of  used-up  investment 
(used-up  "savings")  have  thereupon  emphasized  the  "use- 
lessness"  of  the  "depreciation  reserve."  1  The  proposed 
application  of  this  conception  is  most  easily  given  in  the 
words  of  Professor  Allyn  A.  Young.  His  conclusions,  and 
their  bearing  on  the  problem  of  measuring  reasonableness, 
are  thus  summarized: 

"1.  The  absence  of  such  a  reserve  does  not  necessarily 
mean  that  part  of  the  principal  of  the  investment  has  been 
returned  to  the  proprietors. 

"2.  In  valuation  for  purposes  of  rate  control  no  deduction 
should  be  made  on  account  of  the  depreciation  of  large  and 
varied  properties,  except  for  depreciation  allocated  to  a 
period  in  which  depreciation  accruals  were  regularly  charged 
to  operating  expenses."  a 

In  the  case  of  the  railroads  this  would  generally  mean 
deduction  for  accrued  depreciation  of  rolling  stock  accruing 
since  1908.  All  other  items  of  inventory  (and  equipment, 
prior  to  1908),  rails,  ties,  fences  (whether  nearly  new,  half 
worn  out  or  ready  for  the  scrap  heap),  should  be  appraised 
as  though  new.  The  proposal,  to  say  the  least,  is  startling. 

ume  29,  pages  395-96.  The  present  writer  finds  Dr.  Davis'  argument  con- 
clusive.   See  the  Valuation  Brief  of  1915,  page  240  and  following. 

1  This  concept  of  the  "useless"  depreciation  reserve  apparently  origi- 
nated with  J.  E.  Allison.    See  the  Valuation  Brief  of  1915,  page  196, 
where  counsel  say,  "Such  funds  serve  the  purpose  of  disclosing  and  an- 
alyzing operating  costs." 

2  Quarterly  Journal  of  Economics,  volume  28,  page  663.  A  third  conclu- 
sion, which  need  not  here  be  considered,  is:  "If  depreciation  charges  have 
not  been  required  by  public  authority,  it  cannot  be  assumed  that  the  pro- 
prietors of  a  large  public  service  undertaking  should  have  accumulated 
a  reserve  for  accrued  depreciation." 


120  RAILROAD  VALUATION 

The  basis  for  these  conclusions  is  the  insistence  that  de- 
duction for  accrued  depreciation  in  the  absence  of  reserves 
is  a  regulation  of  "past  profits."  Professor  Young's  ar- 
gument is,  briefly,  that  the  "expectations,  plans,  and 
estimates"  of  "proprietors"  did  not  take  into  account 
accruing  depreciation  as  a  cost  of  operation,  since  the 
reserve  would  have  been  a  permanent  account,  and  there- 
fore "useless"  as  a  source  of  replacements.  The  failure  to 
charge  depreciation  increased  the  "profits"  which  the  com- 
pany apparently  had  earned.  It  was  therefore  entitled  (or 
thought  itself  entitled)  to  declare  this  amount  in  dividends. 
To  deduct  now  for  the  accrued  depreciation  would  scale 
down  the  investment  which  was  being  "maintained"  in  a 
state  of  working  efficiency. 

So  long  as  Professor  Young  attempts  to  uphold  this 
contention  by  economic  reasoning,  he  seems  on  dangerous 
ground.  The  omission  of  the  charge  against  the  inevitable 
wasting  of  capital  goods  serves,  it  is  true,  to  swell  nominal 
profits.  But  to  insist  that  these  nominal  profits  represent 
real  net  income  (as  he  and  Mr.  Allison  appear  to  do)  is  to 
close  one's  eyes  to  the  nature  of  "business  profits."  Profits 
cannot  be  defined  in  terms  of  the  "expectations,  plans,  and 
estimates"  of  proprietors.  They  are  the  residual  share  of 
income  after  all  expenses  of  production  (and  the  cost  of  the 
plant  which  has  "ripened  "  into  a  commodity  or  a  service  is 
a  very  real  part  of  this  cost)  have  been  deducted  from  gross 
income.  Some  one  may  have  been  deceived  into  thinking 
that  profits  were  greater  than  in  fact  they  were.  He  may 
even  have  deceived  himself .  But  the  using  up  of  machinery 
goes  on  quite  apart  from  expectation  or  opinion.  To  omit  a 
charge  for  depreciation  may  exaggerate  the  amount  of 
profit;  but  the  real  net  income  does  not  accrue  until  total 
cost  is  met.  To  deduct  for  accrued  depreciation  cannot 
therefore  represent  a  regulation  of  "past  profits."  On  eco- 
nomic principles  the  failure  to  deduct  for  accrued  depre- 
ciation cannot  be  justified. 


UNIMPAIRED   INVESTMENT  121 

Nor  does  the  absence  of  the  formal  reserve  mean  that 
the  investment  may  not  have  been  kept  intact,  even  in- 
creased. It  is  possible  to  accept  the  first  of  Professor 
Young's  conclusions  as  quoted  without  accepting  his  ar- 
gument. The  reason  why  there  may  have  been  no  return 
of  a  part  of  the  investment  to  the  proprietors  does  not 
lie  in  the  fact  that  a  reserve  would  be  a  permanent  account, 
and  hence  "  useless  "  for  replacement  purposes.  The  reason 
lies  in  the  fact  that  though  depreciation  reserves  have  not 
been  set  up,  the  investment,  especially  in  the  case  of  the 
railroads,  has  frequently  been  kept  up  through  "  money 
put  back  into  the  property." 1  In  an  entirely  haphazard 
manner  the  level  of  "unimpaired  savings"  embodied  in  the 
plant  may  even  have  been  increased,  though  a  state  of 
working  efficiency  (ability  to  turn  out  ton-miles  in  a  given 
period)  has,  it  would  seem,  been  the  ideal  actually  sought. 
And  it  is  because  of  this  practice  that  the  failure  to  es- 
tablish a  depreciation  reserve  has  not  necessarily  meant 
a  return  of  investment  to  the  owners,  or  its  wasting,  with 
the  realization  of  a  business  risk. 

When  the  argument  is  put  upon  considerations  of  pro- 
tecting "innocent  holders,"  of  protecting  "vested  in- 
terests," rather  than  upon  those  of  economic  principles, 
there  is  perhaps  more  to  be  said  for  Professor  Young's 
contention.  The  difficulty  presented  in  these  terms  is 
always  a  real  one.  Professor  Young  would  say  that  had 
these  "proprietors"  conceived  of  depreciation  as  a  "cost" 
regularly  accruing,  rates  might  have  been  higher.  In  the 
case  of  railroad  rates,  such  consequences  of  a  lack  of 
charges  to  depreciation  may  probably  be  discounted. 
Rate  wars  and  treaties  account  for  the  schedules  main- 

1  See  Illinois  Central  R.R.  Co.  v .  I.C.C.,  206  U.S.  441,  462,  where  mak- 
ing improvements  out  of  earnings  was  cited  by  the  railroad  as  an  "axiom." 
The  argument  of  Walker  D.  Hines,  in  the  1910  Advance  Cases  (Evidence, 
page  5290),  is  also  here  pertinent. 


122  RAILROAD   VALUATION 

tained,  and,  whatever  the  accounting  tradition  of  the  day, 
competition  must  have  been  the  force  most  effective  in 
determining  the  general  level  of  rates. 

But  frank  recognition  of  the  actual  economic  situation 
(the  depreciation  of  the  plant)  does  not  prevent  attending  to 
an  "ethical"  element;  and  upon  logical,  not  artificial, 
premises.  That  there  is  a  difficulty  which  is  not  to  be  swept 
aside  by  a  formula  may  be  granted.  The  presence  of  a 
depreciation  reserve  or  its  absence  is  not,  however,  the 
important  economic  issue.  The  present  reasoning  points 
clearly  enough  that,  unless  the  amount  of  the  unimpaired 
investment  is  to  be  overstated,  the  deduction  for  accrued 
depreciation  must  be  made.  If  any  allowance  shall  be 
granted  to  "vested  interests,"  based  on  expectations,  and 
a  definition  of  "profits,"  which  are  not  "profits"  at  all, 
it  can  be  made  in  the  rate  of  return  calculated  on  the 
depreciated  "  value."  The  deviation  from  the  normal  policy 
can  in  this  way  consciously  focus  on  the  abnormal  case 
without  the  danger  of  setting  up  an  illogical  precedent. 

The  confusion  involved  in  the  assumption  that  the  "  de- 
preciation allowance,  wherever  made,  is  for  the  purpose  of 
accumulating  a  fund  with  which  to  cover  the  cost  of 
replacements," 1  accounts  for  a  denial  that  existing  plant  is 
depreciated  so  long  as  replacements  and  repairs  are  made 
as  needed  and  charged  to  operating  expenses  —  the  policy 
of  the  railroads  prior  to  the  accounting  amendment  of  the 
Interstate  Commerce  Act  in  1906.  An  obvious  distinction 
has  been  drawn  between  a  "composite"  and  a  "simple" 
property: 

"A  simple  property  may  be  defined  as  one  which  cannot 
be  economically  renewed  piecemeal,  but  must  be  renewed 
as  a  whole.  A  composite  property  may  be  defined  as  one 
composed  of  two  or  more  simple  properties,  which  simple 
properties  can  be  renewed  independently.  A  railroad  prop- 
erty may  be  described  as  a  composite  property  made  up  of 

1  The  Valuation  Brief  of  1915,  page  166. 


UNIMPAIRED  INVESTMENT  123 

a  great  number  of  simple  properties  of  varying  ages  and  con- 
ditions of  usefulness.  Examples  of  a  simple  property  are  a 
tie,  a  rail,  a  wheel.  Examples  of  a  composite  property  are 
a  car,  a  locomotive,  the  track,  i.e.,  composed  of  rails,  ties, 
ballast,  fastenings,  etc.,  and  the  railroad."  * 

What  is  the  attempted  application  of  these  definitions? 
There  is  no  denial  that  the  simple  properties  deteriorate 
from  age  and  use.  But  "while  physical  deterioration  in  a 
simple  property,  whereby  the  service  life  of  that  property 
is  shortened,  is  depreciation  in  it,  such  physical  deterioration 
in  the  simple  properties  composing  a  railroad  does  not  at 
all  necessarily  mean  that  the  railroad  as  a  whole  is  de- 
preciated." 2  And  why?  Take  the  case  of  the  track: 

"The  track  must  be,  and  is,  indefinitely  maintained,  and 
never  comes  to  the  end  of  its  service  life,  and  never  requires 
replacement  as  a  unit.  Not  coming  to  the  end  of  its  service 
life,  depreciation  due  to  a  loss  of  service  life  does  not  exist 
in  the  track  .  .  .  the  accrued  depreciation  in  these  parts 
(ties,  rails,  fixtures,  etc.)  is  not  depreciation  of  the  track. 
The  track  itself  cannot  be  depreciated  unless  repairs  and 
replacements  on  it  are  neglected."  3 

1  The  Valuation  Brief  of  1915,  page  162. 

8  Ibid.,  page  166. 

8  Ibid.,  pages  23  land  234.  At  page  237,  counsel  continue  in  terms  which 
indicate  a  failure,  or  an  unwillingness,  for  strategic  reasons,  to  recognize 
the  lack  of  logic  in  their  concept  of  depreciation: 

"To  deduct .  .  .  the  accrued  depreciation  in  the  ties,  rails,  etc.,  .  .  . 
would  lead  to  the  absurdity  of  finding  that  the  same  class  of  tie,  of  the 
same  age,  costing  the  same  money  in  place,  is  worth  more  in  one  road 
than  in  the  other,  because  its  service  is  longer  in  the  one  road  than  in  the 
other.  The  life  of  the  same  character  of  tie  will  vary  on  different  roads 
due  to  the  difference  in  use.  Assuming  that  the  life  of  such  a  tie  is  six  years 
on  one  road,  and  nine  years  on  another  road,  and  that  it  has  been  in  place 
three  years  on  each  road,  it  will  be  found  that  it  has  three  years  of  life 
remaining  on  one  road,  or  50  per  cent  of  its  value  new,  and  six  years  of 
life  on  the  other  road,  or  66§  per  cent  of  its  value  new;  all  of  which  shows 
that  the  length  of  service  life  of  the  various  units  composing  the  track  is 
not  a  factor  in  determining  the  value  of  the  track,  but  is  only  a  factor  in  de- 
termining its  cost  of  maintenance.  The  only  service  life  that  is  involved 
in  depreciation  is  the  service  life  of  the  track,  and  this  life  being  continu- 
ous and  indefinite,  depreciation  due  to  service  life  is  not  to  be  considered." 


124  RAILROAD  VALUATION 

The  answer  to  this  train  of  discussion  can  be  briefly 
summarized.  The  argument  not  only  assumes  that  the 
whole  can  be  something  more  than  the  sum  of  its  parts,  but 
it  harks  back  to  the  error  of  assuming  that  maintenance 
in  a  state  of  working  efficiency  is  maintenance  of  the  invest- 
ment. Investment  is  made  in  terms  of  dollars,  and  can 
only  be  measured  in  terms  of  dollars,  and  the  maintenance 
of  the  investment  is  only  attained  through  "putting  earn- 
ings back  into  the  property'*  equal  to  the  amount  of  the 
original  investment  in  capital  goods  used  up  in  furnishing 
current  services.  The  railroad  argument  fails  to  recognize 
the  place  of  capital  goods  in  the  productive  process. 


Ill 

And  what  of  the  indestructible  item  in  the  inventory  — 
the  railroad  site  —  land?  Consideration  must  pass  to  the 
assumption  that  the  railroad  is  entitled  to  a  "reasonable 
share"  —  whatever  that  may  be  interpreted  to  mean  — 
"in  the  general  prosperity  of  the  communities  which  it 
serves,  and  thus  to  attribute  to  its  property  an  increase  in 
value."  l  If  the  "adjacent  land  test"  and  the  "similar" 
land  test,  as  proposed  in  the  Minnesota  decision,  be 
barred  on  logical  grounds,  what  expedient  is  left?  The 
argument  turns  at  each  step  to  original  cost,  to  investment. 

Original  cost,  applied  to  land,  would,  prima  facie,  seem  to 
deny  the  possibility  of  an  "unearned  increment."  It  has 
therefore  been  attacked  on  three  grounds: 

I.  "As  the  company  may  not  be  protected  in  its  actual 
investment,  if  the  value  be  plainly  less,  so  the  making  of 
a  just  return  for  the  use  of  property  involves  the  recogni- 
tion of  its  fair  value,  if  it  be  more  than  its  cost."  2 

1  Minnesota  Rate  Cases,  230  U.S.  352,  455.  Justice  Hughes  merely 
said,  "assuming  that  the  company  is  entitled,"  etc.  He  did  not  say  that 
the  company  is  entitled,  etc.  See  discussion,  above,  page  91. 

»  Justice  Hughes,  Minnesota  Rate  Cases,  230  U.S.  352,  454. 


UNIMPAIRED   INVESTMENT  125 

EC.  "Inasmuch  as  the  land  is  used  in  serving  the  public; 
and  if  not  so  used  could  be  realized  upon  by  the  company  at 
its  present  value,  it  seems  only  fair  that  this  present  value 
should  be  the  basis  for  estimating  the  amount  of  return. 
.  .  .  This  appreciated  value  is  in  the  nature  of  a  profit  in- 
vested for  the  public."  l 

III.  "Not  to  permit  owners  of  the  railroads  ...  to  get 
any  benefit  from  the  unearned  increment  is  to  place  this 
class  in  the  community  at  a  disadvantage  as  compared  with 
other  classes."  2 

The  question,  it  should  be  emphasized,  is  not  whether 
the  railroads  should  be  permitted  to  receive  the  benefit  of 
the  increased  value  of  land  which  is  to  be  taken  from  the 
railroad  service  and  devoted  to  another  entirely  different 
purpose:  as,  for  example,  when  the  building  of  a  union 
terminal  causes  several  railroads  to  place  the  sites  of 
abandoned  stations  upon  the  market.3  In  such  a  case  as 
this,  the  land  is  no  longer  railroad  land.  It  is  business 
land,  and  its  value  is  dependent  upon  the  capitalized  site 
rent  which  it  will  command  for  business  purposes.  When 
the  railroad  made  its  purchase  years  ago  it  withdrew  the 
land  from  business  use.  Now  after  a  period  in  railroad 
service  the  land  is  to  be  returned  to  commercial  or  indus- 
trial use.  In  the  mean  time  the  community  has  built  up, 
and  a  site  perhaps  originally  costing  only  a  few  hundred 
dollars  can  be  sold  for  thousands.  An  "unearned  incre- 

1  Report  of  the  St.  Louis  Public  Service  Commission,  on  Rates  of 
Union  Electric  Light  and  Power  Co.  (1911),  page  33. 

*  W.  H.  Lyon,  Capitalization,  page  236. 

1  The  following  testimony  of  J.  J.  Hill,  Minnesota  Rate  Cases,  Record 
(G.N.),  page  1345,  passes  over  this  fact:  "I  think  that  a  railroad  going 
into  a  new  country  and  building  it  up  and  furnishing  the  facilities  to  open 
it  up  and  doing  all  their  share  of  the  work,  is  entitled  even  to  more  con- 
sideration than  the  man  who  went  out  and  bought  the  land  and  let  it 
lay  and  did  nothing  whatever.  If  the  land  went  from  $1.50  an  acre  to 
$3.00  or  $5.00,  or  from  $10.00  up  to  $25.00  or  $30.00,  as  in  many  cases 
it  has  in  this  State,  nobody  would  challenge  his  right  to  sell  it  at  a  profit; 
I  don't  know  why  the  railroad  should  not  have  the  same  advantage,  be- 
cause they  have  done  something  in  making  it  possible  for  people  to  live 
where  they  could  not  live  before." 


126  RAILROAD  VALUATION 

ment"  thereby  arises,  and  it  arises  because  the  amount  of 
the  "economic  rent"  which  that  site  will  command  has 
increased  over  that  of  the  day  when  the  railroad  made  its 
purchase.  In  such  a  case,  while  the  public  permits  the 
private  individual  to  profit  by  the  increase  in  value,  there 
appears  no  reason  even  to  question  the  parallel  right  of  the 
railroad.  But  this  is  not  the  fundamental  issue  now  under 
discussion,  however  much  it  may  have  been  confused  with 
that  issue. 

Undoubtedly  the  first  argument  cited,  that  based  upon 
"give  and  take,"  upon  consistency,  has  appealed  most 
strongly  to  the  judicial  mind.  The  public  does  not  under- 
write losses;  therefore  any  "unearned  increment"  should 
accrue  to  the  company.  This  conclusion  has  been  assumed 
as  axiomatic.  In  no  case  has  a  reasoned  explanation 
appeared.  It  would  appear,  in  fact,  that  the  argument  was 
used  first  to  justify,  not  an  appreciated  "value,"  but  one 
below  the  amount  of  the  original  cost.  Here,  then,  the 
premises  were  reversed,  from  those  assumed  to  apply  to  the 
railroad;  where,  indeed,  it  could  be  only  in  the  most  excep- 
tional case  that  an  "unearned  increment"  would  not 
appear,  using  the  "adjacent  land"  test.  The  effect  of  the 
coming  of  the  railroad  is  to  increase  at  once  the  value  of  the 
land  in  the  tributary  territory.  But,  in  the  case  of  "  land 
depreciation,"  it  was  decided  that  not  cost  but  "  value " 
should  govern;  the  argument  in  the  lower  court  being 
that,  if  the  land  became  more  valuable,  the  company  was 
"justly  entitled  to  the  benefit  of  the  increased  value"; 
therefore  "those  who  invested  their  money  in  it  and  took 
the  chance  of  an  increase  in  value,  should  bear  the  burden 
of  the  decrease."  l  When,  the  "value"  test  accepted  by 
the  Supreme  Court,  the  land  owned  by  the  company  whose 

1  San  Diego  L.  &  T.  Co.  v.  National  City,  74  Fed.  79,  83;  see  Same  v. 
Jasper,  110  Fed.  702,  714.  It  must  be  remembered  that  these  cases  arose 
under  a  California  statute  establishing  a  "value"  test. 


UNIMPAIRED  INVESTMENT  127 

rates  were  being  considered  showed  an  increase  in  value 
(according  to  the  evidence),  the  argument  was  soon  turned 
around.  The  San  Diego  Land  and  Town  Company  had 
asked  that  the  original  cost  be  considered,  since,  with  the 
collapse  of  the  boom  in  Southern  California,  the  "value" 
was  less.1  In  the  railroad  cases,  as  in  the  local  utility  cases, 
where  the  sites  occupied  by  plants  have  been  surrounded 
by  business  blocks,  etc.,  and  an  "appreciation"  has  been 
claimed,  the  representatives  of  the  public  have  insisted 
upon  cost,  and  those  of  the  private  interests  have  talked 
of  "present  value."2 

The  Supreme  Court  has,  therefore,  had  occasion  to  pass 
upon  the  issue.  In  the  New  York  Gas  Case  the  land  used 
by  the  Consolidated  Gas  Company  had  been  "valued" 
by  Judge  Hough  as  general  business  property,  and  the 
"unearned  increment"  allowed  over  the  protest  of  the 
attorneys  in  opposition.  Justice  Peckham,  passing  upon 
this  question,  announced  the  doctrine  that  "if  the  property 
which  legally  enters  into  the  consideration  of  the  question 

1  Brief  of  J.  D.  Works  for  the  Company,  174  U.S.  739  (National  City 
Case);  and  189  U.S.  439  (Jasper  Case).  The  Wisconsin  Commission  in 
the  Superior  Case  (10  W.R.C.R.  704,  739)  also  used  a  "depreciated" 
value  for  land  bought  in  "boom"  times. 

2  See  Brief  of  Alton  B.  Parker,  Willcox  ».  Consolidated  Gas  Co.,  212 
U.S.  19. 

In  opposition  it  was  alleged  that  the  plea  for  the  cost  basis  in  "  valuing  " 
land  was,  "in  its  last  analysis,  pure  socialism."  Brief  of  James  M.  Beck 
for  the  Company,  page  98.  Mr.  Beck  also  called  the  proposal  one  "for 
the  legislative  equalization  of  fortunes,"  which  "if  addressed  to  a  Single 
Tax  Society,"  etc.  He  even  invited  "the  earnest  consideration"  of  the 
Court  to  the  "irreparable  damage  which  would  be  done  to  investments 
in  this  country,  if  the  doctrine  for  which  the  appellant  contended"  were 
sanctioned.  "Billions  of  dollars  are  invested  in  railroad  properties,  and 
there  is  insistent  public  demand  for  a  revaluation  of  railroad  proper- 
ties as  the  basis  of  determining  the  reasonableness  of  their  charges. 
Most  of  these  railroads  have  been  built  for  many  years,  and  some,  like 
the  Baltimore  and  Ohio,  for  nearly  three  quarters  of  a  century.  Many  of 
them  occupy  a  part  of  their  original  road-beds,  and  still  use  in  part  their 
original  terminal  facilities.  If  these  are  to  be  valued  on  a  basis  of  their 
original  cost,  there  will  be  a  destruction  of  values  which  may  justly  be 
compared  to  the  San  Francisco  earthquake."  Ibid.,  page  103. 


128  RAILROAD   VALUATION 

of  rates  has  increased  in  value  since  it  was  acquired,  the 
company  is  entitled  to  the  benefit  of  such  increase.  That 
is  at  least  the  general  rule."  Then,  lest  he  might  seem  to 
have  committed  the  Court  in  too  positive  terms,  he  con- 
tinued, "We  do  not  say  that  there  may  not  possibly  be  an 
exception  to  it,  where  the  property  may  have  increased  so 
enormously  in  value  as  to  render  a  rate  permitting  a  rea- 
sonable return  upon  such  increased  value,  unjust  to  the 
public."  l  And  in  these  words,  it  is  clear,  Justice  Peckham 
begged  the  whole  question. 

In  the  Minnesota  Rate  Cases,  there  is  the  language  of 
Justice  Hughes  in  part  already  quoted: 

"It  is  clear  that  in  ascertaining  the  present  value  we  are 
not-limited  to  the  consideration  of  the  amount  of  the  actual 
investment.  If  that  has  been  reckless  or  improvident,  losses 
may  be  sustained  which  the  community  does  not  under- 
write. As  the  company  may  not  be  protected  in  its  actual 
investment,  if  the  value  of  its  property  be  plainly  less,  so  the 
making  of  a  just  return  for  the  use  of  the  property  involves 
the  recognition  of  its  fair  value  if  it  be  more  than  its  cost. 
The  property  is  held  in  private  ownership  and  it  is  that  prop- 
erty, and  not  the  original  cost  of  it,  of  which  the  owner  may 
not  be  deprived,  without  due  process  of  law."  2 

The  validity  of  this  argument  necessarily  depends  upon 
the  validity  of  the  premises  upon  which  it  is  based.  Should 

1  Willcox  v.  Consolidated  Gas  Co.,  212  U.S.  19,  52. 

In  Appleton  v.  Appleton  Water  Works  Co.,  the  Wisconsin  Commission 
said : "  If  real  estate  has  enhanced  to  such  an  extent  that  a  return  upon  its 
value  [determined  on  sales  method]  would  be  in  excess  of  the  reasonable 
value  of  the  use  for  the  purpose  to  which  it  is  devoted,  the  excess  value 
should  be  treated  as  surplus,  and  not  as  a  part  of  the  investment." 
5  W.R.C.R.  215,  224. 

*  Minnesota  Rate  Cases,  230  U.S.  352, 454.  See  Cotting  v.  Kansas  City 
S.Y.  Co.,  82  Fed.  850,  854,  and  Brief  of  C.  M.  Dawes  for  the  C.B.  &  Q., 
Evidence,  1910  Advances,  page  3634. 

In  Reagan  v.  Farmers'  Loan  &  Trust  Co.,  Justice  Brewer,  speaking  of 
a  circumstance  when  "cost"  might  not  govern,  said:  "The  construction 
may  have  been  at  a  time  when  material  and  labor  were  at  the  highest 
price,  so  that  the  actual  cost  far  exceeds  the  present  value."  154  U.S. 
362,  412. 


UNIMPAIRED   INVESTMENT  129 

not  the  company  be  protected  in  its  actual  investment? 
Take  the  case  of  a  railroad  which  buys  land  and  builds  a 
plant  to  furnish  transportation.  The  inducement  for  buy- 
ing the  land  is  the  expectation  that,  over  and  above  the 
interest  on  the  plant  itself,  —  over  and  above  any  return 
ascribable  as  profits,  etc.,  —  the  going  rate  of  return  will  be 
earned  upon  the  cost  of  the  site.  Without  the  expectation 
of  earning  this  amount,  the  investment  will  not  be  made. 
From  this  point  of  view,  a  return  upon  the  original  cost  of 
the  real  estate  is  seen  as  a  necessary  part  of  the  long-run 
cost  of  furnishing  transportation.  At  least  this  amount 
must  be  allowed  in  order  to  induce  private  individuals  to 
furnish  funds  for  construction.  The  "give-and-take "  argu- 
ment fails  to  meet  this  significant  issue.  The  basic  premise 
is  invalid. 

Pass,  therefore,  to  the  second  argument  for  the  allowance 
of  an  "unearned  increment."  The  following  from  The  New 
Haven  Validation  Report  presents  the  essential  steps : 

"If  an  individual  or  a  corporation  buys  a  piece  of  prop- 
erty, the  investment  is  not  the  price  of  it,  but  the  property 
itself.  If  the  property  appreciates  in  value,  the  concern  should 
legitimately  expect  and  be  allowed  to  earn  a  proper  income 
upon  its  appreciated  value.  If  it  is  not  able  or  allowed  to  do 
this,  it  would  naturally  sell  the  property  for  its  increased 
value,  and  put  the  money  into  something  which  would  bring 
the  proper  income  upon  that  value."  l 

This  language,  like  most  reasoning  upon  economic  sub- 
jects which  insists  upon  the  "naturalness"  of  a  result,  does 
not  constitute  adequate  analysis.  What  is  here  portrayed 
as  a  "natural"  phenomenon  would  be  a  most  "unnatural" 
one.  And  this  is  because  the  permanent  way  represents  a 

1  Page  61.  The  same  misunderstanding  of  what  constitutes  "invest- 
ment" is  found  in  Consolidated  Gas  Co.  v.  New  York,  157  Fed.  849,  856. 

Investment,  however,  refers  to  the  amount  of  "savings"  which  are  put 
into  the  purchase  of  a  given  site,  to  cost.  Investment  can  only  increase 
with  added  expenditure;  an  "unearned  increment"  in  land  value  means 
an  increase  in  value,  without  an  increase  in  investment.  Why  else 
"unearned"? 


130  RAILROAD   VALUATION 

large  fixed  investment,  which  would  be  lost  with  the  aban- 
donment of  any  portion  of  the  right  of  way.  If  the  railroad 
were  to  discontinue  operations  (and  this  would  constitute 
an  acknowledgment  that  the  investment  in  plant  was  lost 
anyway),  the  land  could  be  sold.  But  where  operations  are 
to  be  continued,  where  the  amounts  spent  in  grading,  track- 
laying,  etc.,  are  not  given  up  as  lost  for  all  time,  one  can  be 
very  skeptical  of  the  "naturalness"  of  the  railroad  policy 
which  would  abandon  an  existing  line  in  order  to  buy  land 
at  a  higher  price.  All  of  the  advantages  which  the  origi- 
nal line  possesses  —  favorable  operating  conditions,  track 
connections,  convenient  station  locations,  etc.  —  would 
hardly  be  abandoned  through  any  semi-automatic  process. 
What  would  the  railroad  gain?  The  new  site  is  costly, 
buildings  must  be  wrecked,  grading  expense  must  be  in- 
curred, etc.  And  all  the  differential  advantages  possessed 
by  the  old  site  are  lost.  It  indeed  seems  difficult  to  be- 
lieve that  such  fanciful  reasoning  should  have  had  serious 
consideration. 

The  third  argument  for  allowance  of  an  unearned  in- 
crement, "that  the  owners  of  railroad  property  are  en- 
titled to  any  increase  in  the  value  of  their  property  that 
may  accrue  from  the  progress  of  the  territory  in  which  it 
lies,  and  that  they  have  as  much  right  to  the  natural  in- 
crements in  the  physical  value  of  their  property  as  the 
owners  of  any  other  property,"  *  raises  an  issue  distinctly 
involving  broad  questions  of  public  policy.  With  these, 
however,  the  present  discussion  is  not  concerned.2  Here 
it  is  sufficient  to  indicate  that  a  logical  discussion  cannot 

1  Buell  v.  CM.  &  St.P.  Ry.  Co.,  1  W.R.C.R.  324,  479.   In  State  Jour- 
nal  Printing  Co.  v.  Madison  G.  &  E.  Co.,  4  W.R.C.R.  501,  579,  the  Wis- 
consin Commission  spoke  of  rents  increasing  with  the  "natural  increase 
in  the  value  of  the  land,"  etc.    See  San  Diego  L.  &  T.  Co.  v.  National 
City,  74  Fed.  79,  83;  and  L.  &  N.  R.R.  Co.  v.  R.R  Commission  of  Ala- 
bama, "intrinsic  worth  "  of  the  land,  196  Fed.  800,  822;  Consolidated  Gas 
Co.  v.  New  York,  157  Fed.  849,  855. 

2  See  the  discussion  below,  page  203. 


UNIMPAIRED  INVESTMENT  131 

be  maintained  from  the  point  of  view  of  "fair  value." 
Before  an  "unearned  increment  "in  land  values  can  ever 
appear,  there  must  be  (other  things  remaining  the  same) 
an  increase  in  the  "economic  rent"  accruing  upon  that 
land.  Under  these  circumstances  an  increase  in  the  annual 
income  which  can  be  earned  upon  the  site  means  an 
increase  in  its  value.  Now  the  moment  that  railroad 
income  extends  beyond  the  point  necessary  to  reward  the 
skill  and  judgment  exercised  in  its  building,  an  "  unearned 
increment"  appears.  But  how  large  this  "unearned  in- 
crement" shall  be  necessarily  depends  upon  the  level  of 
rates. 

But  if  there  cannot  be  any  "unearned  increment"  in 
railroad  land,  apart  from  one  dependent  upon  earnings, 
and  consequently  dependent  upon  rates,  —  the  adjacent 
land  test  in  its  various  phases  being  rejected  —  the  orig- 
inal cost  would  still  seem  to  constitute  the  only  available 
test  of  reasonableness.  Original  cost  measures  investment. 
The  amount  of  any  "  unearned  increment "  must  be  allowed 
for  in  the  rate  of  return. 

Immediately,  however,  another  difficulty  appears :  What 
of  the  lands  which  cost  the  railroad  nothing?  This  ques- 
tion, though  urged  upon  Justice  Hughes,  was  not  consid- 
ered in  his  opinion,  since  "defects"  in  the  proof  made  it 
unnecessary  to  pass  upon  the  further  point.1  Unwarranted 
dependence  upon  the  analogy  between  condemnation  and 
regulation,  and  upon  the  rule  governing  condemnation 
that  "no  inquiry  is  permitted  as  to  how  the  owners  have 
acquired  the  property,  provided  only  it  be  legally  held  by 
them,"  2  has  led  to  the  conclusion  that  the  value  of 

1  Minnesota  Rate  Cases,  230  U.S.  352,  456. 

2  Ames  v.  Union  Pacific,  64  Fed.  165,  176.   Justice  Brewer  also  de- 
clared, "No  inquiry  is  open  as  to  whether  the  owner  has  received  gifts." 
See  Minnesota  Rate  Cases,  Record  (N.P.),  pages  428-36;  also  Evidence, 
1910  Advances,  Brief  of  C.  M.  Dawes  for  the  C.B.  &  Q.,  page  3634;  and 
that  of  Messrs.  Hanson  and  Ellis  for  the  C.M.  &  St.P.,  page  4062. 


132  RAILROAD   VALUATION 

donated  land  is  "just  as  much  to  be  considered  for  rate 
purposes  as  is  the  value  of  any  other  property  devoted  by 
the  railway  company  to  the  use  of  the  public."  "Where 
property  is  given  to  a  railway  for  a  right  of  way,  such 
property  becomes  as  much  a  part  of  the  property  of  the 
railway  company  ...  as  property  purchased.  ..."  In- 
deed, it  is  "  necessary  not  to  be  misled  by  the  fact  either 
that  the  railroad  company  on  its  original  acquirement 
gave  too  much  or  nothing  for  the  property."  1  In  short, 
the  problem  is  simply  one  in  the  determination  of  "pres- 
ent value."  2 

Indeed,  since  Justice  Hughes  left  the  issue  until  such 
time  as  it  is  necessarily  raised,  the  inclusion  of  donated 
property  must  be  conceded  as  the  practice  approved  in  the 
lower  courts.  Judge  Hough  in  the  New  York  Gas  Case  even 
made,  not  title,  but  occupancy,  the  test.  To  him  it  was 
conclusive  that  if  the  company  were  not  occupying  certain 
streets,  "it  would  have  been  occupying  lands  of  sub- 
stantially similar  value  in  the  vicinity  of  its  plants."  3 
The  Master  in  the  Minnesota  Rate  Cases  also  argued  that, 
in  case  of  reproduction,  public  streets  "  would  cost  practi- 
cally as  much  as  private  property."  4  But  in  general  these 
subtleties  have  not  been  indulged  in  by  the  attorneys  for 
the  railroad  companies.  Instead  they  have  seized  on  the 
bigger  question  of  the  status  of  the  right  of  way  and  ter- 
minal lands  which  were  granted  by  the  Government  to  the 
railroads  at  the  time  of  construction.  Quite  worthless  then, 
the  lands  are,  it  is  insisted,  "valuable"  now,  when  the 

1  Report  of  W.  S.  Thorington,  Special  Master,  Central  of  Georgia 
Case,  page  121;  Report,  Western  Railway  of  Alabama  Case,  page  65. 

2  Western  Railway  of  Alabama  v.  R.R.  Commission  of  Alabama,  197 
Fed.  954,  959.     Mr.  Thorington  did  express  some  skepticism  of  the 
validity  of  using  multiples,  but  included  them  on  the  authority  of  the 
decision  of  the  lower  court  in  the  Minnesota  Rate  Cases.  See  his  Report 
in  the  Central  of  Georgia  Case,  pages  122-23. 

»  Consolidated  Gas  Co.  v.  New  York,  157  Fed.  849,  858. 
4  Report  of  Chas.  E.  Otis,  page  224.  See  Shepherd  v.  N.P.  Ry.  Co.,  184 
Fed.  765,  803. 


UNIMPAIRED   INVESTMENT  133 

tributary  territory  is  populated,  when  cities  and  towns  have 
grown  up.  The  Spokane  terminals  which  the  Northern 
Pacific  "valued"  (by  the  "adjacent  land"  and  "multiple" 
test)  at  $7,000,000,  and  which  had  in  large  measure  been 
donated,  serve  to  illustrate  the  situation.  But  along  the 
entire  line  of  the  donated  right  of  way,  the  same  phenome- 
non exists.  Adjacent  land  is  more  valuable. 

This,  of  course,  brings  up  the  old  question  of  measure- 
ment. Let  it  be  granted  that  the  donated  right  of  way 
"belongs  to  the  donee  in  the  same  fullness  as  if  it  had 
been  paid  for."  l  How  fix  upon  a  "  value  "  ?  The  "  adjacent 
land"  test,  with  which,  it  would  seem,  dependence  on 
"railroad  intuition" 2  has  in  such  large  measure  been  com- 
bined, is  fallacious.  To  value  railroad  land  as  other  land 
is  valued,  by  the  capitalization  of  the  "economic  rent," 
means  vicious  reasoning.  Only  the  use  of  original  cost  can 
eliminate  the  fallacies.  Does  this  mean  that,  the  cost  being 
nothing  at  all,  the  donated  land  is  to  be  eliminated  from 
consideration  by  virtue  of  the  nature  of  the  economic 
problem  which  the  test  of  reasonableness  seeks  to  solve? 
Yes,  subject  to  only  one  possible  qualification :  it  would  not 
be  contrary  to  economic  reasoning  to  include  the  lands  at 
their  value  at  the  time  they  were  donated  to  the  railroad. 
But  this  would  constitute  small  comfort  to  the  railroad 
which  built  across  public  lands  which,  in  the  absence  of 
transportation  facilities,  it  was  not  worth  while  to  cul- 
tivate. 

Nor  does  either  programme  mean  injustice  to  the  rail- 
road investor.  The  donation  of  right  of  way  was  made  in 
order  to  render  attractive  the  investment  of  funds  in 
grading,  structures,  and  equipment.  A  part  of  the  usual 
expense  attendant  in  building  was  saved,  since  it  was 
unnecessary  for  the  road  to  make  expenditure  for  the  land 

1  Brief  of  C.  M.  Dawes  for  the  C.B.  &  Q.,  Evidence,  1910  Advances, 
page  3634. 

2  Testimony  of  W.  L.  Park,  of  the  Illinois  Central,  ibid.,  page  605. 


134  RAILROAD   VALUATION 

needed  for  its  service.  The  same  earnings  would  mean  a 
larger  rate  of  return  on  the  smaller  investment.  And,  at 
the  same  time,  the  road  receiving  the  free  right  of  way 
secured  a  differential  advantage  over  any  subsequently 
constructed  competitor  which  would  be  forced  to  buy  its 
right  of  way  and  terminal  sites,  at  prices  representing  the 
capitalization  of  an  economic  rent  dependent  on  the  pres- 
ence of  the  first  road.  The  building  of  the  Great  Northern, 
or  more  recently  of  the  Chicago,  Milwaukee  and  St.  Paul, 
competing  with  the  pioneer  Northern  Pacific,  is  here  a 
case  in  point.  The  St.  Paul  met  the  rates  set  by  the 
pioneer  lines,  but  its  fixed  charges  include  a  payment  of 
interest  upon  purchases  of  lands  which  the  Northern 
Pacific  was  in  large  measure  spared. 

And  this  differential  advantage,  possessed  by  the  North- 
ern Pacific,  is  one  necessarily  permanent.  The  traffic  now 
exists  in  sufficient  volume  to  have  tempted  the  building  of 
a  new  transcontinental  railroad.  But  at  the  time  the  land- 
grant  roads  were  built,  the  promise  of  profit  was  not  so 
certain.  It  was  necessary  to  tempt  investment  by  free 
right  of  way  (which  meant  that  the  same  volume  of  earn- 
ings would  net  a  greater  return  upon  the  investment  made), 
and  by  "land  grants."  1 

1  The  status  of  these  land  grants  has  not  been  questioned  in  the  dis- 
cussion of  rate  regulation.  Nor  should  it  be.  These  grants  were  a  part  of 
the  inducement  for  investment,  but  their  disposition  in  no  sense  of  the 
word  necessarily  concerned  operations  in  the  furnishing  of  transporta- 
tion. The  companies  were  free  to  keep  the  lands,  as  has  the  Northern 
Pacific  to  so  considerable  an  extent;  or  to  dispose  of  them,  diverting  the 
proceeds  to  payments  to  stockholders,  or  to  the  purchase  of  railroad 
plant.  If  the  latter  policy  has  been  followed,  the  plant  so  created  be- 
came a  part  of  the  investment  of  the  company.  But  the  grants  were  of 
land  which  it  was  never  intended  should  be  devoted  to  railroad  purposes. 
They  were  a  part  of  the  bait  which  tempted  the  assumption  of  great  pio- 
neer risks,  which  otherwise  would  not  have  been  assumed. 

The  Valuation  Act  (Section  19a  of  the  Act  to  Regulate  Commerce) 
provides  for  an  investigation  of  "any  aid,  gift,  grant  of  right  of  way, 
or  donation,  made  ...  by  the  Government  of  the  United  States,  or  by 
any  state,  county,  or  municipal  government,  or  by  individuals,"  etc. 


UNIMPAIRED  INVESTMENT  135 

IV 

No  "actual  cost"  appraisal  of  a  railroad  property  has 
been  made.  Even  Mr.  Hammond  V.  Hayes,  who  was  one 
of  the  first  to  suggest  the  possibility  of  making  such 
appraisal,  expressed  entire  skepticism  of  the  applicability 
of  the  expedient  to  the  case  of  the  railroad.1  Very  prob- 
ably he  is  entirely  right,  for  the  St.  Louis  Commission  has 
found  great  difficulty  even  in  the  case  of  a  local  public 
service  company.2  It  is  none  the  less  worth  while  to  in- 

1  "Original  Cost  versus  Replacement  Costs,"  Quarterly  Journal  of 
Economics,  volume  27,  page  628.    Mr.  Hayes  is  satisfied  with  the  refine- 
ment arrived  at  by  securing  a  unit  price  for  "all  elements  for  each  year 
in  the  past,"  though,  obviously  enough,  the  cost  of  materials  and  labor 
are  by  no  means  constant  through  a  year.    But  it  is  sufficient  for  our 
purpose  (remembering  this  qualification)  to  accept  his  description  of  the 
engineering  problem:  "An  inventory  is  prepared  showing  all  plant  units 
now  in  useful  service.  Such  an  inventory  is  identical  with  that  required 
for  ascertaining  replacement  cost.    The  age  of  each  unit  is  ascertained 
and  entered  in  the  inventory  .  .  .  this  figure  for  age  is  necessary  for  a 
determination  of  the  loss  in  value  of  the  investment  arising  from  de- 
preciation. From  this  age  figure  it  is  possible  to  find  how  many  units  of 
each  class  of  elements  were  constructed  in  each  year  in  the  past.  The  sum 
of  the  products  of  the  number  of  units  constructed  each  year  by  the  unit 
costs  for  that  year  will  give  the  original  cost.   Overhead  charges  can  be 
found  for  each  year.  .  .  .  Thus  it  is  seen  that  the  method  of  determining 
original  cost  is  practically  the  same  as  replacement  cost,  except  that  in 
the  case  of  the  original  cost  there  are  several  unit  costs,  one  for  each  year 
in  the  past  for  each  element,  whereas  for  replacement  cost  there  is  but 
one  unit  cost  applicable  to  all  units  of  the  same  kind."    Hammond  V. 
Hayes,  Public  Utilities  ;  Their  Cost  New  and  Depreciation,  page  108. 

2  The  expressed  intention  of  the  St.  Louis  Commission  was  to  arrive 
at  figures  representing  fairly  what  those  costs  should  have  been  "  under 
all  existing  circumstances."    Even  on  this  basis  it  was  not  always  easy 
to  secure  unanimity  of  opinion  on  unit  costs;  and  for  the  older  parts  of  the 
work,  "through  lack  of  reliable  data,"  the  Commission's  engineers  used 
"present  prices."  However,  "having  made  a  complete  detailed  inventory 
of  the  entire  physical  property  .  .  .  the  Commission  assigned  to  each  item, 
as  nearly  as  possible,  its  original  cost  in  place  and  ready  for  service. 
These  costs  were,  when  possible,  taken  from  actual  signed  contracts  in 
the  files  of  the  company,  and  where  such  contracts  did  not  exist,  cost 
estimates  were  made  from  data  for  similar  work,  collected  by  the  engi- 
neering staff  of  the  Commission."  Report,  St.  Louis  Public  Service  Com- 
mission, on  Rates,  Union  Electric  Light  &  Power  Co.,  pages  27,  28,  29. 


136  RAILROAD   VALUATION 

dicate  the  scope  of  such  an  investigation.  For  it  presents 
the  only  appraisal  which  is  in  accord  with  the  trend  of  the 
previous  reasoning.  The  programme  is  simple :  the  problem 
is  to  determine  the  amount  of  the  "  unimpaired  invest- 
ment." Take  each  unit  of  the  plant  (no  matter  how 
minute  must  be  the  classification  of  items),  determine  the 
amount  of  its  original  cost  (including  any  "overhead"), 
appraise  and  deduct  the  accrued  depreciation.1  But  this 
extended  analysis,  presumably  made,  even  for  "reproduc- 
tion," involves  endless  detail.  It  is  subject  to  all  the 
sources  of  error  in  measurement  and  calculation  which 
render  the  cost  of  reproduction  figures  inconclusive  from 
the  point  of  view  of  statistical  significance.  Mr.  Hayes* 
verdict  seems  conclusive :  attempt  to  make  a  cost  appraisal 
of  a  railroad  —  excluding  land,  where  everything  depends 
on  the  state  of  records  —  would  be  in  large  measure 
fruitless.  Perhaps  the  same  conclusion  would  hold  for 
land.2 

The  experience  of  the  Interstate  Commerce  Commis- 
sion in  its  attempt  to  secure  figures  satisfying  the  require- 
ment of  the  Valuation  Law,  calling  for  "original  cost  to 
date,"  upholds  this  judgment.  The  Commission's  account- 
ants have  sought  to  tie  up  entries  on  the  books  with  the 
physical  units  of  plant.  The  Texas  Midland  and  the  New 
Orleans,  Texas  &  Mexico,  the  one  a  line  of  112  miles,  the 
other  of  175  miles,  were  selected  for  experimental  investi- 
gations. The  results  can  be  given  in  Director  Prouty's  own 
words: 


See  James  E.  Allison,  "Ethical  and  Economic  Elements  in  Public  Service 
Valuation,"  Quarterly  Journal  of  Economies,  volume  27,  pages  30,  81. 

1  To  a  total  determined  on  this  basis,  the  cost  of  plant  acquired  through 
"  maintenance,"  etc.,  could  be  added  in  the  future,  and  deduction  for 
accruing  depreciation  or  abandonment  made  without  destroying  the 
meaning  of  the  figures.     Always  they  would  measure  the  volume  of 
"savings"  (in  dollars)  still  embodied  in  the  railroad  property. 

2  See  Minnesota  Rate  Cases,  Record  (G.N.),  page  190  and  following, 
and  page  292  and  following. 


UNIMPAIRED  INVESTMENT  137 

"We  found  that,  with  respect  to  certain  things  that  could 
be  done,  and  with  respect  to  certain  things  it  could  not  be 
done  at  all.  As  to  the  roadway  and  the  tracks  and  every- 
thing which  went  into  them,  we  could  not  tell  anything  about 
the  place  where  the  expenditures  had  been  made.  We  could 
not  tell  to  what  part  or  what  section  of  that  road  the  ex- 
penditure should  be  assigned.  With  structures  it  was  some- 
what different.  We  could  say  that  a  certain  amount  of  the 
expenses  had  gone  to  bridges,  and  we  could  say  within  cer- 
tain limits  that  a  certain  expenditure  had  been  made  upon 
a  particular  bridge.  For  instance,  $100,000  had  been  ex- 
pended in  one  year  on  bridges.  Now  we  could  locate  the 
particular  bridges  to  the  amount  of  $75,000  out  of  the 
$100,000,  but  there  was  still  left  $25,000  which  could  not  be 
located,  which  simply  meant  bridges  wherever  the  bridges 
might  be. 

"Not  only  that,  we  found  it  was  impossible  to  tell  whether 
the  amount  which  had  been  expended  upon  a  particular 
bridge  completed  that  bridge.  Here  is  a  minute  which 
shows  that  there  has  been  paid  out  at  different  times  upon  a 
particular  bridge  $10,000,  but  you  cannot  see  from  the 
books  of  the  company  whether  that  $10,000  completed  that 
bridge  or  whether  there  was  some  other  expenditure  for 
labor  or  materials  which  also  went  into  that  bridge."  l 

Mr.  Prouty  summarized  his  discussion  by  calling  the 
figure  found  in  this  investigation  a  "practical  nullity."  It 
was  his  conviction  that  the  work  involved  was  "  absolutely 
thrown  away."  He  even  expressed  his  hope  that  the  Com- 
mission, seeing  the  uselessness  of  the  task,  would  relieve 
the  accounting  office  of  the  Division  of  Valuation  of 
further  attempt  to  secure  "cost  to  date."  2  In  so  far  as 

1  National  Association  of  Railway  Commissioners,  1914,  Proceedings, 
26th  Annual  Meeting,  page  137  and  following.  The  quotation  is  from  a 
stenographer's  transcript. 

8  Ibid.  The  Director  of  Valuation  would  also  seem  to  hold  that  the 
previous  charging  to  capital  (betterments)  or  to  operating  was  important 
for  appraisal  purposes: 

"  Now  you  see  that  that  is  a  tremendous  undertaking.  It  is  a  tremendous 
undertaking  with  respect  to  a  little  railroad  like  the  Texas  Midland.  You 
have  got  to  handle  every  item.  You  have  got  to  examine  it,  analyze  it, 
and  assign  it.  That  was  done,  with  the  conclusion  that  when  your  invest- 


138  RAILROAD   VALUATION 

the  policy  of  the  Division  of  Valuation  may  be  expected 
to  direct  the  course  of  determining  "final  valuations"  by 
the  Interstate  Commerce  Commission,  the  largest  em- 
phasis would  thus  seem  destined  to  fall  upon  "cost  of 
reproduction."  1 

But  a  conclusion  that  the  "level,"  or  "volume,"  or 
"amount"  of  investment  in  plant  cannot  be  determined 


ment  account  had  been  rewritten  it  was  good  for  nothing.  In  the  first 
place,  it  is  absolutely  impossible  to-day,  as  the  books  of  account  of  the 
railroads  in  this  country  have  been  kept,  to  correct  errors  which  may  have 
been  made  in  the  original  distribution  of  those  items.  Take  a  voucher  for 
a  pay-roll  and  a  voucher  for  supplies.  Here  is  a  bill  of  timber.  You  can- 
not pass  upon  the  question  whether  it  was  used  for  an  addition  and  a 
betterment  of  that  property,  or  whether  it  was  used  for  a  renewal  which 
should  properly  be  charged  to  operation.  But,  worse  than  that,  there  is 
no  way  in  which  you  can  tell  what  retirement  has  been  made,  and  what 
retirement  should  therefore  be  taken  out  of  that  investment  account. 
So  that  we  felt  that  the  investment  account  when  rewritten  was  not  much 
better  than  it  was  before  we  attacked  it,  and  it  is  my  own  feeling  that  if 
you  were  to  treat  the  books  of  every  carrier  in  this  country  in  that  way, 
while  you  might  detect  and  would  detect  many  instances  of  mistakes,  the 
general  result  would  add  very  little  to  the  knowledge  which  you  now  have, 
and  it  might  be  a  source  of  misinformation  rather  than  of  more  accurate 
information." 

1  Writing  at  a  later  date,  however,  Mr.  Prouty  recognized  that  "the 
value  of  a  railroad  for  rate-making  purposes  has  never  yet  been  clearly 
defined."  Still,  are  not  "courts,  commissions,  and  economists,  one  in  the 
opinion  that  for  the  determination  of  this  question,  certain  facts  must 
be  marshaled,  of  which  the  principal  are,  cost  of  reproduction  new,  cost 
of  reproduction  less  depreciation,  original  investment  in  the  property  and 
the  history  of  that  investment"?  Mr.  Prouty  then  reverted  to  the  "legal 
principle  ":  "A  railroad  is  entitled  under  the  Constitution  to  a  fair  return 
upon  the  fair  value  of  the  property."  C.  A.  Prouty,  "Why  the  Valuation 
should  not  be  discontinued,"  Railway  Age  Gazette,  volume  58,  pages  7-8 
(January  1,  1915). 

See  also  Mr.  Prouty's  address  on  "  Valuation,"  reprinted  in  the  Railway 
Library  for  1913,  page  215  and  following.  The  notable  cases  handled  by 
Mr.  Prouty  while  on  the  Commission  were  the  Advance  Case  of  1903, 
9  I.C.C.  382;  the  Spokane  Case,  15  I.C.C.  376;  and  the  Eastern  Advance 
Case  of  1910,  20  I.C.C.  243.  See  also  the  testimony  of  B.  H.  Meyer, 
before  the  Senate  Committee;  and  of  Judson  Clements,  before  the  House 
Committee,  Senate  Report  on  Valuation,  etc.  It  would  seem  that  all  three 
members  of  the  Commission  looked  upon  "cost  of  reproduction"  as  in 
itself  an  end. 


UNIMPAIRED  INVESTMENT  139 

with  any  usable  degree  of  accuracy  does  not  justify  the 
use  of  "cost  of  reproduction"  figures.1  Even  were  "cost 
of  reproduction"  desired,  not  as  an  end  in  itself,  but 
only  as  a  rough  measure  of  investment  (i.e.,  actual  cost), 
the  result  would  be  quite  inconclusive.  The  most  that 
could  be  expected  from  such  figures  would  be  a  rough 
standard  that  might  indicate,  within  very  broad  limits, 
the  relative  level  of  investment  in  different  lines.  If  one 
road  had  a  "cost  of  reproduction"  of  $30,000  a  mile,  and 
another  of  $60,000,  there  would  perhaps  be  some  rough 
indication  that  one  line  represented  about  twice  the  in- 
vestment of  the  other.  But  the  figures  of  "cost  of  repro- 
duction" would  not  measure  a  "value"  (i.e.,  an  un- 
impaired investment  in  tangible  property)  of  $30,000,  or 
$60,000. 

A  challenge  is  thus  directed  at  the  possible  usefulness  of 
the  present  Federal  "physical  valuation"  which  seeks  to 
determine  the  "cost  of  reproduction  new"  and  the  "cost 
of  reproduction  less  depreciation"  of  the  railroads.  The 
figures  can  be  only  the  grossest  estimates,  bearing  no  real 
relation  to  the  problem  of  determining  a  reasonable  long- 
run  cost  of  producing  transportation  service.  However 
detailed  may  be  the  field  investigation,  —  and  the  Divi- 
sion of  Valuation,  though  apparently  committed  to  the 
illogical  "adjacent  land"  test,  plans  also  a  thorough 
resurvey,2 — a  large  element  of  error  is  inevitable.  De- 
pendence upon  "judgment,"  "imagination,"  and  "expert 
opinion,"  in  measuring,  in  classifying,  in  choosing  unit 
prices,  in  appraising  depreciation,  will  render  the  figures 

1  See  the  discussion  by  G.  F.  Swain,  Proceedings,  Am.  Soc.,  C.E., 
volume  40,  pages  1418-19,  an  extreme  example  of  this  attitude;  also  the 
paper  by  W.  J.  Wilgus,  presented  at  the  meeting  of  October  1,  1913;  and 
the  discussion  thereon  by  members  of  the  society,  Transactions,  Am.  Soc., 
C.E.,  volume  77,  pages  203-345. 

2  See  Instructions  for  the  Field  Work  of  the  Roadway  and  Track 
Department  of  the  Interstate  Commerce  Commission,  Division  of  Valu- 
ation. 


140  RAILROAD  VALUATION 

devoid  of  real  usefulness  in  scientific  calculation.  This  con- 
clusion must  hold  quite  apart  from  the  unsoundness  in- 
herent in  "cost  of  reproduction"  as  a  measure  of  the 
reasonableness  of  income. 

And  there  is  always  the  danger  that  such  figures,  falling 
into  uncritical  hands,  may  have  a  meaning  attached  to 
them  which  they  do  not  possess.  It  will  be  easy  enough  to 
translate  totals  gathered  by  a  Government  agency  into 
terms  of  "value,"  though  the  figures  actually  represent  at 
best  only  an  engineering  guess  of  "reproduction  cost,"  a 
purely  forced  conception.  Even  the  worthless  State  figures 
have  been  quoted  as  indicating  that  the  gross  capitaliza- 
tion of  the  roads  appraised  did  not  exceed  the  "invest- 
ment." * 

1  See  S.  O.  Dunn,  American  Transportation  Question,  page  113,  and 
"The  Valuation  of  Railways,"  Atlantic  Monthly,  volume  113,  pages  411-12; 
Professor  F.  H.  Dixon's  paper  on  "Valuation  and  Capitalization,"  pub- 
lished by  the  Bureau  of  Railway  Economics,  1911;  and  an  address  by 
Howard  Elliott,  of  the  New  Haven,  before  the  Alumni  Association  of  the 
Massachusetts  Institute  of  Technology,  January  9,  1915.  Mr.  Elliott 
used  the  Washington  figures,  the  South  Dakota  figures  ("cost  of  re- 
production new"),  the  Minnesota  figures  ("depreciation  deducted"), 
without  regard  to  the  statistical  premises  on  which  the  figures  were 
gathered.  He  even  ascribed  weight  to  the  New  Haven  Validation  Report. 
See  also  Professor  William  Z.  Ripley,  Railroads,  Finance  and  Organization 
(page  341),  a  series  of  tabulations  based  upon  the  State  figures. 


CHAPTER  VI 

THE  INTANGIBLE   ELEMENTS  OF   "FAIR  VALUE" 

Introduction:  The  regulation-condemnation  analogy,  141. 
I.  Franchise  value,  142. 

The  railroad  franchise,  142.  —  Condemnation  proceedings,  143. 

—  Taxation,  144.  —  The  analogy   once    more,  145.  —  Alabama 
Rate  Cases,  147. 

II.  Strategic  value,  149. 

The  market  value  test  of  the  Washington  Commission,  150.  — 
Operating  conditions,  151.  —  The  railway  value  of  land,  153. 

III.  Going  value,  159. 

"Going  value"  and  "good  will,"   159. — The  comparative 
plant,  160.  —The  rule  of  C.C.C.  &  St.L.  Ry.  Co.  v.  Backus,  163. 

—  Appraisal  of  "going  value,"  164. 

IV.  The  Wisconsin  theory  of  cost,  166. 

Deficits  below  a  fair  return,  166. — The  Western  Advance 
Case  of  1910, 167.  —  The  surplus,  171.  —  Reasonable  deficits,  174. 

—  The  assumption  of  risk,  175. 

V.  The  "cost"  of  business  connections,  and  of  creating  an  organiza- 
tion, 177. 

The  New  Jersey  Case,  177.  —  Abandoned  plant  as  the  "cost  of 
progress,"  180.  —  Selling  costs  as  investment,  183. 

THE  assumed  analogy  between  condemnation  and 
regulation  which  led  to  the  original  suggestion  of  the 
"valuation"  test  has  never  been  subjected  to  a  reasoned 
analysis  by  the  judiciary.  The  lower  courts,  where  the 
point  has  been  raised  (and  this  has  been  infrequently)  have 
seldom  perceived  "any  difference  in  the  principles  appli- 
cable to  the  two  cases."  *  Justice  Swayze,  of  the  New 
Jersey  Supreme  Court,  however,  drew  a  sharp  line  of  dis- 
tinction: in  the  case  of  condemnation,  an  "exchange 

1  Spring  Valley  W.W.  c.  San  Francisco,  124  Fed.  574,  594;  San  Diego 
Water  Co.  v.  San  Diego,  118  Cal.  556,  567;  Kings  County  Lighting  Co. 
v.  Willcox,  156  App.  Div.  N.Y.  603,  606.  See  Brief  of  Messrs.  Dunlap, 
Norton  and  Lathrop  for  the  Santa  Fe,  Evidence,  1910  Advances,  page 
3601;  The  Valuation  Brief  of  1915,  pages  273-314;  and  Pierce  Butler, 
of  the  railroad  counsel,  "Valuation  of  Railway  Property,"  Journal  of 
Political  Economy,  volume  23,  page  23  and  following. 


J 


142  RAILROAD  VALUATION 

value"  is  sought;  in  the  case  of  rate  regulation,  "the  ques- 
tion is  what  valuation  and  rate  will  tempt  investment."  1 
The  United  States  Supreme  Court  has  implied  in  condem- 
nation suits  that  it  does  not  now  look  upon  the  two  sets 
of  cases  as  raising  the  same  issue.2  But  there  has  been 
no  attempt  to  bring  together  this  apparent  denial  and  the 
original  condemnation-regulation  analogy,  where  con- 
sideration of  regulation,  as  pro  tanto  condemnation,  led 
to  the  voicing  of  the  valuation  doctrine.  In  point  of  fact, 
the  presence  of  the  word  "value"  in  the  opinions  has  not 
infrequently  caused  indiscriminate  application,  to  one  set 
of  cases,  of  expedients  developed  to  meet  quite  different 
problems.  The  uncertainty  of  treatment  has,  however, 
been  most  pronounced  in  the  case  of  the  intangible 
elements :  "  franchise  value  " ;  "  market  value  " ;  "  strategic 
value";  "good-will";  "the  cost  of  building  up  the  busi- 
ness"; "  going  value."  And  it  is  with  these  that  the  present 
chapter  is  concerned. 


The  franchise  of  a  railroad  represents  simply  the  power  to 
build  the  line,  to  operate  it,  and  to  collect  rates.  Without 
these  rights,  the  railroad  property  would  be  so  much  scrap. 
The  franchise,  therefore,  insures  the  investor  that,  so  long 
as  his  interest  warrants  operating  the  road,  the  State  will 
not  refuse  him  permission.  The  railroad  can  continue  as  a 
going  concern  subject  only  to  its  public  obligations.3 

In  two  sets  of  cases — in  condemnation  proceedings  and 
in  tax  litigation — the  courts  have  had  occasion  to  pass  upon 

1  Public  Service  Gas  Co.  v.  Board  of  Public  Utility  Commissioners,  87 
Atlantic  651,  658. 

2  Omaha  Water  Works  Co.  v .  Omaha,  218  U.S.  180, 202,  a  purchase  case. 

*  "The  franchise  has  added  no  producing  power  to  the  realty  or  per- 
sonalty; it  has  but  authorized  their  employment  in  a  particular  way,  and 
protected  the  owners  while  so  employing  them."  Consolidated  Gas  Co. 
v.  New  York,  157  Fed.  849,  874. 


INTANGIBLES  143 

the  determination  of  "franchise  value."  The  dependence  of 
this  "  value  "  upon  earnings  has  been  generally  recognized. 
In  Monongahela  Navigation  Company  v.  United  States, 
the  Supreme  Court  specifically  ordered  payment  for  the 
franchise  of  a  company  which  owned  a  lock  condemned  by 
the  National  Government.  There  had  been  an  appraisal  of 
the  tangible  property,  but  no  allowance  had  been  made  for 
the  value  of  the  franchise :  the  right  to  collect  tolls,  and  to 
earn  a  maximum  return  of  eight  per  cent.  Justice  Brewer 
held  that,  before  the  owners  could  be  deprived  of  their 
property,  "the  whole  value  must  be  paid;  and  that  value 
depends  largely  upon  the  productiveness  of  the  property. 
.  .  .  When  by  the  taking  of  the  tangible  property,  the 
owner  is  actually  deprived  of  the  franchise  to  take  tolls, 
just  compensation  requires  payment,  not  merely  of  the  / 
value  of  the  tangible  property  itself,  but  also  of  the 
franchise  of  which  he  is  deprived."  1  This  argument  is  of 
course  weak  in  assuming  the  value  of  a  permanent  invest- 
ment to  be  something  intrinsic,  and  in  attempting  to 
divorce  the  value  of  the  franchise  from  the  value  of  the 
plant.  Strict  reasoning  would  indicate  that  the  franchise 
permits  the  operation  as  a  going  concern,  and  thereby  brings 
it  about  that  the  plant  (here,  a  lock)  is  to  be  valued  by  the 
process 'of  capitalizing  the  earnings.  True,  the  franchise  is 
essential  in  order  that  there  may  be  earnings.  But  the 
source  of  revenue  is  the  service  which  only  the  plant  can 
provide.  Without  a  plant  there  can  be  no  earnings. 
Attempt  to  insist  upon  a  value  of  the  franchise,  apart  from  j 
the  value  of  the  plant  to  which  it  gives  life,  is  clearly 
impossible.2 

1  148  U.S.  312,  343.  Justice  Brewer  had  no  occasion  to  direct  how  the 
valuation  of  the  franchise  should  be  made.   See  the  Valuation  Brief  of 
1915,  page  514  and  following. 

2  This  reasoning  reverts  to  the  whole  process  of  "valuing"  capital 
goods;  the  dependence  of  their  exchange  value  upon  the  value  of  their 
services,  etc.    See  F.  W.  Taussig,  Principles  of  Economics,  volume  1, 
page  151. 


144  RAILROAD  VALUATION 

Taxation  methods  as  developed  have,  however,  come  to 
insist  upon  drawing  a  line  between  the  "value"  of  the 
plant  and  the  "value"  of  the  franchise.  And  these 
"values"  have  not  been  exchange  values,  the  subject  of 
the  discussion  in  the  preceding  paragraph,  but  "values" 
as  determined  by  appraisal.  Fixing  upon  a  "physical 
value"  of  the  plant,  a  rate  of  return  has  been  calculated 
upon  this.  Then  the  amount  of  the  net  earnings,  after 
deducting  this  "fair  return,"  has  been  calculated  and 
capitalized,  the  resulting  figure  being  the  "value "of  the 
franchise.  The  basis  for  this  insistence  upon  "franchise 
value"  has  been  the  fact  that  assessing  railroad  and  public 
utility  plants,  under  the  general  property  tax,  had  failed 
to  secure  an  amount  as  large  as  would  be  fixed  were 
earnings  capitalized.  Insistence  that  the  franchise  was 
property,  "  taxable,  inheritable,  alienable,"  soon  led  to  an 
attempt  to  tax  its  "  value."  The  only  way  in  which  such  a 
sum  could  be  determined,  was  by  the  process  of  isolating  a 
part  of  the  net  earnings.1 

But  to  include  the  result  of  such  a  calculation  in  the 
basis  used  for  measuring  the  reasonableness  of  the  return 
is  to  step  again  into  the  vicious  circle  of  reasoning.  The 
amount  of  this  "franchise  value"  is  reflected  in  earnings 
once  for  all.  These  earnings  cannot  possibly  be  treated  as 

1  The  first  conspicuous  attempt  to  determine  upon  the  "value"  of 
"non-physical  elements  of  railway  property,"  for  taxation  purposes,  was 
made  by  Henry  C.  Adams,  in  connection  with  the  Michigan  Appraisal 
of  1901.  The  appraised  value  of  the  physical  properties  which  he  used 
was  the  "valuation"  based  on  "cost  of  reproduction  less  depreciation" 
made  by  M.  E.  Cooley,  the  inadequacy  of  which  has  been  demonstrated. 
Further  indication  that  Professor  Adams  has  looked  upon  this  "valua- 
tion" as  worthy  of  serious  consideration  is  found  in  his  letter  to  former 
Chairman  Knapp,  of  the  Interstate  Commerce  Commission,  quoted, 
Senate  Report  an  Valuation,  page  216.  See  Bulletin  21,  Bureau  of  the 
Census,  Commercial  Valuation  of  Railway  Operating  Property,  page  80. 

E.  R.  Johnson  has  approved  of  the  use  of  such  a  "valuation"  in  meas- 
uring the  reasonableness  of  rates,  as  "equitable  to  all  parties  in  interest 
—  the  public,  the  investor,  and  the  railroad  company."  American  Rail- 
way Transportation,  pages  93,  94. 


INTANGIBLES  145 

independent  of  the  level  of  charges.  To  test  the  reason- 
ableness of  the  return  from  earnings  upon  a  "valuation  " 
itself  dependent  upon  the  volume  of  earnings  is,  of  course, 
to  estop  regulation. 

Attempt  to  hold  to  the  doctrine  that  regulation  is  pro 
tanto  condemnation  led  Judge  Hough,  of  the  United  States 
District  Court,  into  this  very  difficulty.  He  had  before 
him  figures  purporting  to  show  the  "present  value"  of  the 
plants  of  the  Consolidated  Gas  Company,  determined  by 
an  "expert"  appraisal.  He  was  endeavoring  to  decide 
whether  an  amount  should  be  added  to  this  "  value  "  to 
take  account  of  the  franchise  which  the  company  insisted 
was  "property"  from  which  an  income  could  be  "justly 
and  lawfully  demanded."  l  Refusing  "to  minimize  and 
distinguish"  the  decisions  which  had  assumed  that  con- 
demnation and  regulation  were  in  spirit  identical  pro- 
ceedings, it  was  left  "  to  the  higher  tribunals  to  make  dis- 
tinctions which,  if  drawn  by  the  lower  court,  would  .  .  . 
savor  of  presumption."  2  Accordingly  Judge  Hough  set 
about  to  determine  the  valuation  of  a  franchise,  which 
his  common  sense  led  him  to  believe  should  not  be 
"valued." 

Immediately  he  became  hopelessly  involved.  "If  its 
earning  power  be  reduced  by  regulation,  the  value  of  the 
property  is  pro  tanto  reduced,  and  since  the  franchise  is 
property,  the  value  of  the  franchise  is  also  reduced.  .  .  . 
It  is  obviously  true  that  if  franchises  have  inherent  value, 
and  yet  may  be  disregarded  in  regulating  rates,  it  would 
be  an  easy  matter  to  regulate  profits  as  near  the  vanishing 
point  as  might  be  necessary,  and  then  condemn  property 
whose  franchises  had  been  so  practically  destroyed  by 
regulation,  at  a  price  far  below  its  worth."  3  Next  pointing 

1  Consolidated  Gas  Co.  v.  New  York,  157  Fed.  849,  875-76.  Such 
allowance  had  been  made  by  the  Master  on  the  capitalization  basis. 

*  Ibid. 

*  Ibid.,  page  876  (the  italics  are  the  writer's).  It  is  possible  that  Judge 


146  RAILROAD   VALUATION 

out  that  the  method  of  assessment  for  taxation  involved  a 
capitalization  of  earnings  (above  a  "fair  return  on  the 
assessed  value  of  the  plant"),  he  indicated  that,  while  this 
was  "undoubtedly  an  easy  and  convenient  method  of 
ascertaining  the  value  of  the  franchise,"  it  failed  to  recog- 
nize that  "as  long  as  the  tangible  property  earns  any- 
thing, and  the  franchise  exists,  the  franchise  contributes  to 
the  earning  power,  because  it  is  only  by  virtue  of  the 
franchise  that  anything  at  all  is  earned."  There  is  even  a 
candid  recognition  of  the  existence  of  the  fallacy,  followed 
almost  immediately  after  with  the  statement  that  "the 
value  of  a  franchise  depends  wholly  upon  what  is  earned 
under  it,"  l  whether  regulation  or  condemnation  be  under 
consideration.2  The  result  of  this  wavering  and  contradic- 
tion was  the  assignment  of  an  arbitrary  sum  as  the  value  of 
the  franchises.3 

Hough  introduced  this  reasoning  in  order  to  bring  the  issue  to  the  atten- 
tion of  the  Supreme  Court.  If  so,  he  failed  completely  to  secure  the  re- 
sult desired.  See  Consolidated  Gas  Co.  v.  Mayer,  146  Fed.  150, 157,  the 
decision  at  the  time  the  temporary  injunction  was  granted.  The  argument 
here  influenced  the  Master,  A.  H.  Masten,  who  reported  to  Judge  Hough. 
See  Report  of  the  Master,  pages  186,  200,  204,  210,  Willcox  t>.  Consoli- 
dated Gas  Co.,  212  U.S.  19. 

1  Consolidated  Gas  Co.  v.  New  York,  157  Fed.  877,  878. 

2  The  Brief  of  John  A.  Garver,  on  "Franchises"  for  the  Company, 
Willcox  v.  Consolidated  Gas  Company,  212  U.S.  19,  is  full  of  this  same 
circular  reasoning.    See   especially  pages  20-23.    At  page  23  he  cited 
Smyth  v.  Ames,  169  U.S.  466,  declaring,  "In  Smyth  v.  Ames,  the  Court, 
in  considering  the  method  of  ascertaining  the  value  of  the  property, 
employed  language  which  necessarily  included  special  franchises,  stating 
(page  547)  that  there  should  be  included  the  amount  and  market  value  of 
its  stocks  and  bonds  .  .  .  the  probable  earning  capacity  of  the  property." 

3  On  appeal,  Justice  Peckham  took  refuge  behind  a  technicality,  and, 
though  indicating  that  he  understood  the  connection  between  "franchise 
value"  and  earnings,  made  an  allowance  for  the  franchise  at  the  amount 
at  which  it  had  been  capitalized  when  the  company  was  formed;  though 
using  an  appraisal  of  the  existing  "physical "  assets.  But  he  made  the  clear 
reservation  that  his  decision  could  form  no  precedent  where  similar 
facts  did  not  exist.    (212  U.S.  19,  44-48.)   Whitten,  Valuation  of  Public 
Service  Corporations,  pages  594-612,  is  devoted  to  an  extended  discussion 
of  the  facts  peculiar  to  this  case. 

See  Cedar  Rapids  Gas  Light  Co.  v.  Cedar  Rapids,  223  U.S.  655,  669; 


INTANGIBLES  147 

But,  entirely  aside  from  the  analogy  which  has  been 
assumed  to  exist  between  regulation  and  condemnation 
proceedings,  is  there  not  "force"  in  "the  argument  that  the 
franchise  ought  to  be  worth  something  for  rate-fixing 
purposes,  if  it  is  worth  millions  for  taxation"?  *  So  long  . 
as  the  railroad  pays  a  "franchise  tax,"  should  not  the  *^ 
"value"  of  the  franchise  be  included  in  the  measure  of 
reasonableness?  An  affirmative  answer  to  this  question 
was  secured  by  the  Masters  in  the  Alabama  Rate  Cases 
through  invoking  -a  theory  of  estoppel.  And  Judge  Jones, 
to  whom  their  Reports  were  submitted,  accepting  the  con- 
clusion without  the  formality  of  examining  the  premises 
on  which  it  was  based,  was  content  merely  to  "cite  the 
authorities."  2  The  Reports  of  the  Masters,  therefore,  con- 
tain the  essential  steps  in  the  argument.3  Mr.  Gunter's 
Report  in  the  South  and  North  Alabama  Case  includes 
the  portions  germane  to  the  present  discussion.4 

The  State  Tax  Commission  had  determined  the  "true 
value,  for  taxation,  of  franchises  or  intangible  property  "  by 
deducting  "the  assessed  value  of  the  tangible,  real  and 
personal  property"  from  the  market  value  of  the  stocks 

and  especially  Public  Service  Gas  Co.  v.  Board  of  Public  Utility  Com- 
missioners, 87  Atlantic  651,  a  decision  of  Justice  Swayze,  of  the  New 
Jersey  Supreme  Court.  The  latter  opinion  was  overruled  by  the  New 
Jersey  Court  of  Errors  and  Appeals,  which,  citing  taxation  and  con- 
demnation cases,  reversed  the  Supreme  Court,  because  the  "value"  of 
the  franchise  had  been  ignored  in  determining  the  basis  for  measuring  the 
reasonableness  of  the  return.  Public  Service  Gas  Co.  v.  Board  of  Public 
Utility  Commissioners,  92  Atlantic  606.  This  opinion  was  then  over- 
ruled in  94  Atlantic  634. 

1  Spring  Valley  Water  Co.  v.  San  Francisco,  165  Fed.  649,  667,  696. 
See  Consolidated  Gas  Co.  v.  Mayer,  146  Fed.  150,  157;  and  G.  F.  Swain, 
the  New  Haven  Validation  Report,  page  57. 

2  L.  &  N.  R.R.  Co.  v.  R.R.  Commission  of  Alabama,  196  Fed.  800, 822, 823. 

3  Report  of  W.  A.  Gunter,  Special  Master,  South  &  North  Alabama 
Case,  page  42;  Louisville  &  Nashville  Case,  page  98;  Report  of  W.  S. 
Thorington,  Special  Master,  Central  of  Georgia  Case,  page  105;  Western 
of  Alabama  Case,  page  51. 

4  Mr.  Gunter's  Reports,  finished  in  advance  of  those  of  Mr.  Thorington, 
were  drawn  on  by  the  latter  for  argument  and  conclusions. 


J 


148  RAILROAD  VALUATION 

and  bonds . l  Surely  "  corporate  property,  highly  rated  and 
taxed  by  the  State  through  an  official  commission  having 
such  matters  in  charge,  should  be  represented  in  the  rates 
allowed  by  the  State."  2 

/  That  this  "  franchise  value  "  was  found  by  a  capitalization 
^of  earnings  (through  the  medium  of  the  securities  market) 
troubled  neither  of  the  Masters;  nor,  for  that  matter, 
the  Court  to  which  they  reported.3  The  danger  seems  at 
one  time  to  have  been  realized,  at  least  by  Mr.  Gunter: 
"  When  the  question  is  one  of  the  reasonableness  of  rates, 
the  value  which  determines  the  rates  should  not  be  deter- 
mined by  the  rates  themselves,  or  revenues  based  on 
them."4  But  when  the  attorneys  for  the  State  protested, 
alleging  that  the  value  of  the  franchise  was  based  upon 
earnings  ("the  capacity  to  earn  profits"),  they  were  met 
with  the  answer  that  the  same  objection  would  apply  to 
"almost  all"  the  railroad  property.  "The  value  of  its 
structure  is  based  on  the  capacity  to  earn  profits,  and  in 
large  part  would  be  worthless  without  this  feature,  and 
would  become  more  valuable  as  profits  increased."  5  Mr. 
Thorington  spoke  in  similar  vein:  "This  argument  goes 
too  far;  the  proposition  is  equally  true  of  the  physical 
properties  of  a  railroad;  then*  value  depends  on  the  earning 
capacity  of  the  road,  and  fluctuates  with  the  earning  ca- 

1  See  General  Laws  of  Alabama,  1907,  pages  342,  348.   The  Masters' 
Reports  give  figures,  but  do  not  indicate  the  process  of  their  determina- 
tion. The  amounts,  of  course,  vary  from  year  to  year. 

2  Report  of  W.  A.  Gunter,  South  &  North  Alabama  Case,  page  43; 
Louisville  &  Nashville  Case,  page  99;  Report  of  W.  S.  Thorington,  Central 
of  Georgia  Case,  page  106;  Western  of  Alabama  Case,  page  52. 

a  L.  &  N.  R.R.  Co.  v.  R.R.  Commission  of  Alabama,  196  Fed.  800, 
822;  Western  of  Alabama  Ry.  Co.  v.  Same,  197  Fed.  954.  Both  cases  are 
cited  in  the  Valuation  Brief  of  1915,  page  527. 

4  Report,  South  &  North  Alabama  Case,  page  82. 

6  Ibid.,  page  42;  Report,  Louisville  &  Nashville  Case,  page  98.  It 
is  this  argument  which  commended  itself  to  Mr.  Thorington  as  "being 
sound"  (Report,  Western  of  Alabama  Case,  page  55);  and  to  Judge  Jones 
as  representing  "able"  treatment  (L.  &  N.  R.R.  Co.  v.  R.R.  Commis- 
sion of  Alabama,  196  Fed.  800,  822). 


INTANGIBLES  149 

parity."  l  These  rulings  clearly  work  into  the  circle.  And 
this  taint  must  bar,  once  for  all,  any  "valuation*'  of  the 
franchise  which  is  not  entirely  independent  of  earnings. 
In  other  words,  has  the  franchise  a  "cost"?  If  so,  such  a 
cost  would  constitute  a  legitimate  organization  expense. 


II 

What  has  been  meant  by  "strate^cjvalue"  can  be  best 
shown  by  a  discussion  of  the  "market  value"  test  of  the 
Washington  Commission.  The  Washington  Commission 
fell  into  the  error  of  attempting  to  capitalize  the  differential 
gains  accruing  to  the  better  situated  railroads  in  the  State, 
and  to  use  a  figure  so  determined  as  a  measure  of  the  reason- 
ableness of  rates.  But,  since  everything  was  done  through 
the  "exercise  of  judgment,"  the  vicious  reasoning  is  not 
readily  apparent.  The  difficulty  with  the  Washington 
Commission  originated  in  a  conscious  effort  to  apply  the 
"rule"  in  Smyth  v.  Ames.2  But  the  "market  value"  as 
"found"  by  the  Commission  had  no  reference  to  selling 
price.  It  was  a  "true  market  value,"  fixed  "as  a  fact"  by 
members  of  a  Commission  "attempting"  to  act  as  would 
"intelligent  business  men."  The  Commission  assumed  that 
the  considerations  governing  a  "prudent  business  man"  in 
the  purchase  of  the  property,  or  those  of  the  owners  in  fix- 
ing a  selling  price,  were  "the  same  considerations  that 
should  govern  a  railroad  commission  in  determining  the 
market  value  of  a  railroad  property."  3 

1  Report,  Central  of  Georgia  Case,  page  105. 

1  First  Annual  Report,  Railroad  Commission  of  Washington,  pages  10 
and  15;  Second  and  Third  Annual  Reports,  page  127. 

8  Report  of  the  Committee  on  Railroad  Taxes,  etc.,  Proceedings,  22d 
Annual  Meeting,  National  Association  of  Railway  Commissioners,  dis- 
cussion, pages  146,  147, 148.  This  Report  (a  paraphrase  of  Reasonable 
Railway  Rates,  by  3.  C.  Lawrence,  of  the  Washington  Commission)  was 
apparently  written  by  Mr.  Lawrence,  to  describe  the  Washington 
method,  which,  the  Report  declared,  solved  "impossible  problems."  At 
any  rate,  he  alone  took  up  the  burden  of  its  defense,  although  the 


150  RAILROAD   VALUATION 

And  what  were  these  considerations?  The  "most  im- 
portant facts"  were  (according  to  the  Washington  Com- 
mission) : 

"The  actual  cost  of  construction. 
"Cost  of  reproduction  new. 
"The  depreciated  value. 

"The  amount  and  market  value  of  the  stocks  and  bonds 
issued,  with  a  full  financial  history  of  the  road. 
"The  density  of  population  and  traffic. 
"The  nature  and  permanence  of  population  and  traffic. 
"Facilities  for  doing  business. 
"Physical  characteristics. 
"The  amount  of  earnings  and  operating  expenses."  l 

Under  each  of  these  subheadings,  the  Commission  made 
formal  "findings  of  fact."  2 

For  the  Great  Northern,  for  the  Northern  Pacific,  and 
for  the  Oregon  Railroad  and  Navigation  Company,  the 
three  principal  lines,  the  "findings "were  in  large  measure 
parallel.  There  was  a  high  density  of  traffic  combined  with 
a  permanent  population,  "adding  value  to  the>said  lines." 
Similarly,  the  presence  of  grain  elevators,  flour  mills,  saw- 
mills, promised  the  continuance  of  traffic  which  could  be 
economically  handled.  This  insurance  of  traffic  and  the 
possession  of  adequate  terminals,  warehouses,  and  docks, 

Report  was  signed  by  B.  H.  Meyer,  of  the  Interstate  Commerce  Com- 
mission, and  others. 

1  "All  of  the  facts  .  .  .  are  pertinent  .  .  .  but  none  are  controlling." 
Report  of  the  Committee  on  Railroad  Taxes,  etc.,  ibid.,  page  139.  See 
also  First  Annual  Report,  Railroad  Commission  of  Washington,  page  315; 
and  J.  C.  Lawrence,  Reasonable  Railway  Rates,  page  3.   Also  the  Inter- 
state Commerce  Commission,  In  the  Matter  of  Advances,  etc.  (1903),  9 
I.C.C.  382,  402:  "Moreover,  the  value  of  a  railway  system  does  not  de- 
pend upon  the  mere  cost  of  its  embankment  or  its  equipment.    It  is 
rather  a  question  of  its  location,  of  connections,  of  terminal  facilities,  of 
enterprises,  along  its  line;  and  shall  nothing  be  allowed  to  the  foresight 
and  ability  which  have  marked  out  and  perfected  that  system?" 

2  Valuations  made  on  this  basis  were  upheld  for  tax  purposes  by 
the   Washington  Supreme  Court.     Northern  Pacific  Ry.   Co.  v.  The 
State,  147  Pacific  45. 


INTANGIBLES  151 

added  "a  value."  *  These  elements  were  important  par- 
ticularly because  of  their  effect  upon  gross  earnings.  Favor- 
able gradients  and  curvature  (the  "physical  characteris- 
tics"), on  the  other  hand,  were  reflected  in  low  operating 
costs.2  And  so,  at  tedious  length,  the  Commission  accounted 
for  every  mile  of  curvature  (never  the  degree,  the  really 
significant  item),  and  every  foot  of  rise  and  fall,  though 
omitting  the  important  factor  in  tonnage  rating,  the  ruling 
grade.  And  where,  as  with  the  Oregon  Railroad  and 
Navigation  Company,  the  haul  was  almost  entirely 

1  Second  and  Third  Annual  Reports,  Railroad  Commission  of  Washing- 
ton (N.P.),  page  165;  (G.N.),  page  287;  (O.K.  &  N.  Co.),  page  421. 
See  testimony  of  Frank  Nay,  Comptroller  of  the  Rock  Island,  Evidence, 
1910  Advances,  page  365;  of  C.  J.  McPherson  of  the  Missouri  Pacific, 
ibid.,  page  846,  and  of  Howard  Elliott,  Minnesota  Rate  Cases,  Record 
(N.P.),  page  1257  and  following.  Also  the  Valuation  Brief  of  1915;  pages 
483-86,  512-14. 

2  J.  C.  Lawrence,  Reasonable  Railway  Rates,  page  9;  Second  and  Third 
Annual  Reports,  Railroad  Commission  of  Washington,  pages  185-91, 
351-53,  432-34. 

The  following  summary  of  the  testimony  of  Howard  Elliott,  on  the  ele- 
ments on  the  Northern  Pacific  property  "adding  value  in  addition  to  the 
mere  physical  values  of  its  component  parts,"  is  here  pertinent: 

Mr.  Elliott  "described  the  location  of  the  lines,  the  character  of  the 
country,  towns  and  cities,  through  which  they  run,  the  terminal  facilities 
owned  at  points  where  traffic  is  received  or  delivered,  the  growing  charac- 
ter of  the  country  and  the  nature  of  the  tonnage  tributary  to  the  road, 
demonstrating  how  all  of  these  elements  create  values  in  the  property. 
He  analyzed  the  grades,  showing  that  they  are  favorable  and  calculated 
to  permit  the  Northern  Pacific  lines  to  meet  competition;  demonstrated 
that  the  property  has  been  well  cared  for  and  is  widely  known;  that  it  pos- 
sesses an  efficient  organization;  that  it  reaches  from  the  Great  Lakes  to 
tide-water  on  the  Pacific  Ocean,  and  that,  it  being  the  pioneer  line  in 
many  of  the  communities  through  which  it  runs,  industries  have  been 
built  up  about  it  and  are,  therefore,  naturally  tributary  to  it.  This  creates 
a  constant  current  of  traffic  toward  it  and  in  a  country  where  population 
is  growing  and  commerce  increasing,  it  demonstrates  that  the  property  has 
future  prospects  for  growth  in  business.  He  finally  summed  up  all  of  the 
elements  of  intangible  values  thus  referred  to  by  saying,  that  while  it  is 
impossible  to  measure  by  any  sum  the  amount  of  such  values,  in  his  judg- 
ment the  property,  as  a  commercial  enterprise  for  doing  a  transportation 
business,  is  worth  at  least  fifteen  per  cent  more  than  the  same  system 
newly  constructed."  Brief  for  the  Companies,  page  359,  Minnesota  Rate 
Cases,  230  U.S.  352. 


I 


152  RAILROAD  VALUATION 

down  grade,  a  relatively  high  "market  value"  was  the 
result.1 

The  Northern  Pacific  even  had  "great  value"  added  to 
its  lines  through  the  possession  of  control  of  the  North- 
western Improvement  Company,  from  which  it  bought  coal 
at  a  price  considerably  under  that  paid  by  the  other  Wash- 
ington roads.2  Similarly,  a  value  was  added  "where  a  road 
had  electrified  its  operations  over  mountain  grades  by  use 
of  water  power  which  it  owns,  cheapening  and  safeguarding 
operations."3  And  the  road,  so  located  that  it  could  not  be 
paralleled  and  made  to  suffer  from  competition,  occupied  a 
"strategic  position"  to  be  recognized  in  a  determination  of 
"market  value."  4 

This  "market  value"  was  fixed  by  the  Commission  "as 
a  fact."  A  market  value  determined  by  consideration  of 
security  quotations  "  would  be  a  good  deal  like  lifting  our- 
selves by  our  bootstraps."  5  Yet  a  circuitous  resort  to 
"judgment"  in  no  sense  evades  the  circle  in  reasoning, 
which  looks  to  exchange  value  as  a  test  of  reasonableness. 
The  factors,  which  the  Washington  Commission  insisted 
"added"  a  "value,"  are  significant  only  because  of  their 
relation  to  earnings.  Clearly  they  bear  no  relation  to  cost 
or  investment.  The  Commission  was  insisting  upon  a 
capitalization  of  the  net  earnings  which  accrue  through  the 

1  Proceedings,  22d  Annual  Meeting,  National  Association  of  Railway 
Commissioners,  page  147.  The  same  point  was  made  in  1886  by  James 
Fentrees,  one  of  the  counsel  in  Stone  v.  Farmers'  Loan  and  Trust 
Co.,  Brief,  page  26,  116  U.S.  307;  likewise  by  R.  E.  T.  Riggs,  "Prob- 
lems of  Railroad  Valuation,"  Columbia  Law  Review,  volume  '13,  page 
685. 

1  Second  and  Third  Annual  Reports,  Railroad  Commission  of  Washing- 
ton, page  165. 

8  J.  C.  Lawrence,  Reasonable  Railway  Rates,  page  9. 

4  Proceedings,  22d  Annual  Meeting,  National  Association  of  Railway 
Commissioners,  page  148,  and  page  144,  referring  to  the  O.R.  &  N.  Co. 
See  L.  &  N.  Ry.  Co.  v.  R.R.  Commission  of  Alabama,  196  Fed.  800,  820, 
where  competition  is  indicated  as  lowering  "value." 

5  Mr.  Lawrence  so  declared  in  the  discussion  of  his  Report,  ibid.,  page 
147. 


INTANGIBLES  153 

possession  of  differential  advantages,  a  capitalization  of 
the  economic  rent  of  the  site.1 

The  same  fundamental  problem  appeared  in  the  Minne- 
sota Rate  Cases,  though  presented  in  a  slightly  different 
light.  A  large  part  of  the  railroad  holdings  in  the  Twin 
Cities  lay  along  the  Mississippi,  and  in  Duluth,  along 
the  harbor  front,  an  entirely  typical  situation.  In  St.  Paul, 
for  example,  the  peculiar  topography  (the  city  rising  high 
above  the  river  bottom  where  the  yards  lay)  restricted 
very  materially  the  area  available  for  railroad  terminals 
possessing  easy  access  to  the  business  district.2  (It  would 
have  been  contrary  to  the  hypothesis  to  assume  the  busi- 
ness district  elsewhere  than  in  the  location  near  the  existing 
yards,  where  it  had  grown  due  to  the  very  presence  of  the 
yards!)  Accordingly  the  experts  hired  by  the  railroads  to 
make  a  "valuation"  took  into  consideration  the  fact  that 
the  most  available  use  of  the  bottom  and  "plateau"  lands 
would  be  for  railroad  purposes.  Railroad  use  representing 
one  of  the  "highest  uses  of  land,"  it  was  possible  to  fix 
prices  per  square  foot  considerably  above  what  the  value 
of  the  land  would  be  if  occupied  by  broken-down  hovels  — 
the  other  great  "use"  for  the  bottom  lands  in  American 

1  Nowhere  is  the  entire  failure  of  the  Washington  Commission  to 
grasp  the  problem  better  illustrated  than  in  the  following  statement  of 
Mr.  Lawrence:  "The  Chicago,  Milwaukee  and  Pi^get  Sound  started  the 
construction  of  its  line  through  the  State  of  Washington,  almost  parallel- 
ing the  Northern  Pacific,  and  we  asked  the  question:  which  is  worth 
more,  costing  the  same,  the  Milwaukee  paralleling  the  Northern  Pacific, 
new  roadbed,  no  facilities  for  doing  business,  not  established  as  a  going 
concern,  or  the  Northern  Pacific,  long  in  business,  warehouses,  factories, 
industries  of  all  kinds  built  up,  with  the  facilities  for  doing  business,  and 
actually  doing  a  profitable  business  as  a  going  concern;  which  is  worth 
the  more?  Would  not  the  Milwaukee  pay  the  Northern  Pacific  far  more 
than  the  cost  of  its  property  now  rather  than  expend  a  similar  sum,  and 
then  wait  for  the  business  to  come?"  Proceedings,  22d  Annual  Meeting, 
National  Association  of  Railway  Commissioners,  pages  173-74.  All  of 
this,  however  true,  is  of  course  simply  beside  the  point.  It  is  sufficient 
to  ask:  what  of  it? 

8  Minnesota  Rate  Cases,  Record  (N.P.),  page  1127;  see  testimony  of 
D.  C.  Morgan,  pages  2001,  2006,  2008. 


154  RAILROAD   VALUATION 

cities.1  The  same  general  method  was  followed  in  Minne- 
apolis. In  Duluth,  however,  in  the  Master's  phrase,  "the 
appraisers  were  much  more  moderate  in  fixing  values  and 
seemed  to  have  adjusted  the  same  with  reference  to  the 
adaptability  of  the  property  for  general  business  enter- 
prises, and  not  to  have  taken  into  account  their  special  and 
increased  value  for  railroad  purposes."  This  error  the 
Master  corrected  by  increasing  their  figures  by  twenty-five 
per  cent  to  cover  both  the  "railroad  value"  and  an  allow- 
ance for  acquisition  and  consequential  damages.  In  the 
other  cities  he  made  an  allowance  of  five  per  cent  to  cover 
the  latter  factors.2 

Judge  Sanborn  accepted  the  land  "  valuations  "  reported 
by  the  Master;  Justice  Hughes  in  the  Supreme  Court  re- 
jected them  unceremoniously.  The  grounds  for  his  rejec- 
tion were  two  in  number;  the  one  looking  simply  to  the 
precedents  cited  from  the  field  of  condemnation,  the  other 
looking  more  deeply  into  the  economic  problem.  In  the 

1  Minnesota  Rate  Cases,  Record  (N.P.),  page  1425.    See  testimony 
of  J.  J.  Hill,  Record  (G.N.),  page  1347. 

The  following  excerpt  from  Mr.  O.  L.  Taylor's  testimony  illustrates  the 
theory  of  the  experts  and  of  the  railroad: 

"Q.  I  understood  you  to  say  that  railway  property  for  terminals  and 
right  of  way  occupies  a  class  of  its  own? 

"A.  Yes,  it  is  not  to  be  compared  with  ordinary  isolated  pieces  of  real 
estate. 

"Q.  Why  shouldn't  you  compare  a  right  of  way  or  a  terminal  occupied 
for  railway  purposes  with  adjacent  property? 

"A.  In  the  first  place,  it  is  put  to  a  different  use;  the  value  as  based  on 
that  use  is  different.  In  the  second  place,  it  becomes  an  entire  and  com- 
pleted creation;  it  ceases  to  be  a  commodity  that  is  offered  in  the  general 
market;  it  is  not  dependent  on  the  little  fluctuations,  the  temporary 
stringency  of  money,  the  individual  necessity  of  sale,  and  the  various 
elements  that  go  to  make  the  prices  of  real  estate  viewed  as  an  ordinary 
salable  commodity. 

"Q.  Then  would  you  not  expect  the  railroad  property  to  follow  the 
fluctuations  of  property  immediately  adjacent  to  it? 

"A.  Not  to  any  appreciable  extent." 

Record  (G.N.),  page  377. 

2  Report  of  Chas.  E.  Otis,  page  222.   See  testimony  of  J.  D.  Stryker, 
of  the  Duluth  appraisers,  Record  (G.N.),  page  600. 


INTANGIBLES  155 

event  of  condemnation  proceedings,  it  was  held,  an  owner 
would  not  be  entitled  to  demand  payment  of  an  amount 
which  property  might  be  deemed  worth  to  the  company; 
nor  payment  of  an  enhanced  value  by  virtue  of  the  purpose 
for  which  it  was  taken.  There  was  no  sound  basis,  there- 
fore, for  allowance  of  such  imaginary  amounts  in  the  case  of 
appraisal  for  measuring  reasonableness.  And  these  con- 
clusions Justice  Hughes  supported  by  citation  of  authori- 
ties: "Supposing  the  railroad  to  be  obliterated,  and  the 
lands  to  be  held  by  others,  the  owner  of  each  parcel  would 
be  entitled  to  receive,  on  its  condemnation,  its  fair  market 
value  for  all  its  available  uses  and  purposes,"  declared 
Justice  Hughes.  Indeed,  "if  in  the  case  of  any  such 
owner,  his  property  had  a  peculiar  value,  or  special  adapta- 
tion for  railroad  purposes,  that  would  be  an  element  to  be 
considered."  It  is  not  easy  to  harmonize  these  citations 
with  the  conclusion  drawn: 

"But  still  the  inquiry  would  be  as  to  the  fair  market  value 
of  the  property;  as  to  what  the  owner  had  lost,  and  not  what 
the  taker  had  gained.  The  owner  would  not  be  entitled  to 
demand  payment  of  the  amount  which  the  property  might 
be  deemed  worth  to  the  company;  or  of  an  enhanced  value 
by  virtue  of  the  purpose  for  which  it  was  taken;  or  of  an  in- 
crease over  its  fair  market  value,  by  reason  of  any  added 
value  supposed  to  result  from  its  combination  with  tracts 
acquired  from  others  so  as  to  make  it  a  part  of  a  continuous 
railroad  right-of-way  held  in  one  ownership."  l 

This  mode  of  handling,  of  course,  represented  a  mere 
maintenance  of  the  condemnation  analogy;  an  extension  of 
principles  developed  to  cover  an  entirely  different  funda- 
mental issue.  The  holding  of  the  Court  standing  alone, 
therefore,  is  hardly  final  for  the  economist. 

Nor  have  the  railroad  attorneys  accepted  the  doctrine  as 

1  Minnesota  Rate  Cases,  230  U.S.  352,  451,  citing  Boom  Company  v. 
Patterson,  98  U.S.  403;  Shoemaker  v.  U.S.,  147  U.S.  282;  U.S.  v.  Chandler- 
Dunbar  Water  Power  Co.,  229  U.S.  53. 


156  RAILROAD   VALUATION 

conclusive.1  The  failure  to  reject  outright  the  condemna- 
tion analogy  has  resulted  in  a  return  to  the  attack.  The 
Valuation  Brief  of  1915  cited  the  cases  used  by  Justice 
Hughes  (and  the  Minnesota  Rate  Cases  as  well),  in  support 
of  the  contention  urged: 

"In  the  case  of  right  of  way,  station  grounds  and  ter- 
minals, as  in  the  case  of  other  lands  of  considerable  area,  the 
value  of  the  whole  is  greater  than  the  sum  of  the  values  of 
the  parcels  comprising  the  same,  and  there  are  elements, 
such  as  continuity,  shape,  suitableness  for  railroad  use, 
etc.,  which  must  be  taken  into  account  and  allowed  for."  2 

Unless  there  shall  be  a  clean-cut  enunciation  of  the  princi- 
ple that  regulation  is  not  condemnation,  and  that  different 
considerations  govern  the  two  sets  of  cases,  a  consistent 
argument  based  on  citations  may  be  maintained  in  these 
terms,  however  inadequate  the  analysis. 

But  Justice  Hughes'  further  discussion  went  straight  to 
the  basis  of  the  difficulty:  "For  the  purpose  of  making 
rates  is  land  devoted  to  the  public  use  to  be  treated 
(irrespective  of  improvements)  not  only  as  increasing  in 
value  by  reason  of  the  activities  and  general  prosperity  of 
the  community,  but  as  constantly  outstripping  in  this  in- 
crease, all  neighboring  lands  of  like  character,  devoted  to 
other  uses?"  No.  And  why?  Because  "the  railway 
value  of  land"  —  "a  large  body  of  land  in  continuous 
ownership,"  representing  one  of  the  "highest  uses  of 
land"  —  is  "an  increment  which  in  the  last  analysis  must 
rest  on  an  estimate  of  the  value  of  the  railroad  use  as  com- 
pared with  other  business  use;  it  involves  an  appreciation 
of  the  returns  from  rates,  which  rates  themselves  are  in 

1  The  Valuation  Brief  of  1915,  page  273:  "The  present  value  of  each 
piece  of  land  used  for  transportation,  must  be  determined  upon  the  same 
principles  which  govern  in  case  of  condemnation  of  private  property  for 
public  use";  citing  Reagan  v.  Farmers'  Loan  &  Trust  Co.,  154  U.S.  362; 
Ames  v.  Union  Pacific,  64  Fed.  165. 

2  See  the  Valuation  Brief  of  1915,  page  314  and  following. 


INTANGIBLES  157 

dispute."  1  In  other  words,  "railway  value,"  at  a  date 
subsequent  to  the  time  of  original  purchase,  means  a 
capitalization  (surely  a  hazy  procedure  in  the  minds  of  the 
appraisers  anyway)  of  the  differential  advantages  possessed 
by  the  site.  The  reason  why  a  railroad  company  is  ready  to 
pay  high  prices  for  land  which  it  can  use  for  yards  and 
depot  grounds,  without  considerable  grading,  is  because  of 
the  necessity  of  conforming  to  construction  standards.  The 
low  land,  therefore,  possesses  a  differential  advantage  over 
tracts  where  large  amounts  of  excavation  or  fill  would  be 
needed.  It  is  this  fact  which  accounts  for  the  presence  of 
the  railroad  in  river  valleys  everywhere.  Not  because  the 
use  for  railroad  purposes  represents  a  higher  use  does  land, 
valueless,  or  nearly  valueless,  for  other  purposes  acquire 
value,  but  because  the  possession  of  level  land  means  a 
saving  in  building  and  a  saving  in  operation.  The  "higher 
use"  is  a  result,  not  a  cause.  So  much  is  commonplace 
analysis  in  terms  of  the  theory  of  rent.2 

1  Minnesota  Rate  Cases,  230  U.S.  352,  453-55. 

1  The  following  excerpt  from  the  record  does  combine  a  consideration  of 
the  "higher  use"  with  a  realization  of  the  differential  advantage,  but  in 
very  unsure  language: 

"A.  But,  you  take  the  property  going  up  Trout  Brook  or  Phalen  Creek 
gorges,  it  has  almost  no  value  from  a  residence  point  of  view  —  down  in 
a  gulley,  subject  under  normal  conditions  to  overflow,  deprived  of  proper 
ventilation,  and  almost  wholly  unfit  for  ordinary  purposes  of  dwellings; 
and  yet,  offering  a  unique  and  ideal  situation  for  a  railroad,  escaping  grade 
crossings,  coming  into  the  city  on  the  level  of  the  river,  and  having  any 
number  of  very  unusual  and  valuable  features  from  a  railroad  point  of 
view;  but  for  all  ordinary  real  estate  purposes,  having  next  to  no  value. 

"Q.  The  result  of  that  is  that  the  gorge  being  available  for  railway 
purposes,  that  land  becomes  normal  does  it  not? 

"A.  Becomes  normal? 

"Q.  Yes.  If  there  were  going  to  be  no  railroads,  the  fact  that  it  was 
in  the  gully,  the  fact  that  it  is  barren,  as  well  as  the  fact  that  there  is  no 
proper  ventilation,  would  practically  deprive  it  of  any  value,  wouldn't 
it? 

"A.  It  would  to  a  very  large  extent. 

"Q.  Yes;  but  because  it  can  be  used  for  a  railroad  purpose,  it  be- 
comes normal  land,  does  it  not? 

"  A.  No;  it  becomes  abnormal,  because  it  jumps  right  over  the  ordinary 


158  RAILROAD  VALUATION 

Yet  the  railroad  appraisers,  the  railroad  attorneys,  and 
the  Master,  in  insisting  upon  the  concept  of  the  "railroad 
value  of  land,'*  however  uncertain  their  statement,  were 
entirely  right  if  the  problem  be  conceived  of  as  one  in  the 
determination  of  "value."  For  the  value  of  land  in  any 
case  depends  upon  the  capitalization  of  the  rent  which 
accrues  on  that  land.1  This  is  true  of  agricultural  land; 
and  it  is  true  of  urban  sites.  It  is  equally  true  of  land 
devoted  to  the  railroad  service,  once  for  all.  Much 
land,  indeed,  worthless  for  agriculture,  and  far  from  urban 
centers,  is  extremely  "valuable"  when  sought  for  railroad 
construction.  The  possession  of  a  canyon  pass,  a  river- 
bank,  or  a  sloping  hillside  may  well  mean  saving  in  original 
outlay  and  in  operating  costs  through  all  time.  Such  land 
is  in  a  position  essentially  similar  to  that  occupied  by  rich 
land  located  close  to  a  market,  or  to  the  site  on  the  busiest 
corner  of  a  city.  Lands  peculiarly  suited  for  the  use  of  a 
railroad  are  in  demand  because  they  do  offer  differential 
advantages;  but  the  extent  of  these  advantages  can  be 
measured  only  through  the  effect  on  income.2  Strategic 

use  to  be  capable  of  that  very  highest,  or  one  of  the  highest,  uses  to  which 
lands  can  be  put. 

"  Q.  You  think  it  is  better,  you  think  the  barrenness  of  the  soil,  and  the 
lack  of  ventilation,  and  the  curving  of  the  gorge  make  it  better  for  rail- 
road purposes? 

"A.  Not  the  curving  of  the  gorge,  but  the  general  topographical  situ- 
ation; the  fact  of  its  being  below  the  grade  renders  it  of  just  the  value 
that  it  would  cost  to  cut  that  out. 

"Q.  Yes;  that  is  right. 

"A.  Above  what  it  would  be  if  it  was  on  a  level. 

"Q.  Yes;  it  may  be  worth  the  additional  amount  that  it  would  cost  to 
cut  that  out? 

"A.  Yes." 

Testimony  of  O.  L.  Taylor,  Minnesota  Rate  Cases,  Record  (G.N.),  page 
386. 

1  By  "rent,"  meaning  "strict  economic  rent,"  "site  rent."  See  F.  W. 
Taussig,  Principles  of  Economics,  volume  2,  chapters  42-44. 

2  See  argument  of  T.  W.  Hulme,  Valuation  Conference  of  May  27-29, 
1915,  Proceedings,  pages  120-27;  and  especially  the  classic  discussion  in 
Wellington,  Economic  Theory  of  Railway  Location,  chapters  in-v. 


INTANGIBLES  159 

situation,  adaptability,  "railway  value,"  mean  nothing 
until  that  advantage  is  realized  in  terms  of  income.  How 
otherwise  "  value  "  the  Royal  Gorge  occupied  by  the  Denver 
and  Rio  Grande  Railroad,  or  the  Delaware  "Water  Gap"?  l 

III 

That  there  can  be  a  substantial  difference  between 
"  good- will "  and  "  going  value  "  from  the  economic  point  of 
view  is  difficult  to  see.  The  courts  have  insisted  that  such 
a  difference  exists.  But  the  basis  for  this  insistence  has 
been  purely  technical.  Good-will,  in  the  standard  defini- 
tion of  the  American  courts,  is  "  all  that  disposition  which 
customers  entertain  toward  the  house  of  business  identi- 
fied by  the  particular  name  or  firm,  and  which  may  induce 
them  to  continue  giving  their  custom  to  it."  2  What  has 
since  come  to  be  known  as  "going  value"  was  described  by 
Justice  Brewer,  in  a  case  involving  the  taking  over  of  a 
water  plant,  as  "the  value  which  flows  from  the  estab- 
lished connections  between  the  pipes  and  the  buildings  of 
the  city."  s  Now,  since  the  customer  who  deals  with  a 
monopoly  must  resort  to  the  old  stand  or  go  without,  his 
disposition  toward  such  a  company  can  count  for  naught. 
Good-will  is  a  characteristic  of  competitive  industry.4 

1  See  also  the  discussion,  below,  page  203. 

2  Wasbburn  v.  National  Wall  Paper  Co.,  81  Fed.  17,  20. 

See  Cedar  Rapids  Gas  Light  Co.  v.  Cedar  Rapids,  120  Northwestern 
966,  969. 

3  National  Water  Works  Co.  v.  Kansas  City,  62  Fed.  853,  864;  followed, 
in  substance,  Omaha  v.  Omaha  Water  Co.,  218  U.S.  180,  203,  and  in  the 
cases  there  cited. 

4  See  Willcox  v.  Consolidated  Gas  Co.,  212  U.S.  19,  52;  Spring  Valley 
W.W.  v.  San  Francisco,  192  Fed.  137,  168. 

The  following,  from  the  testimony  of  Commissioner  B.  H.  Meyer  before 
the  House  Committee  on  Interstate  Commerce,  in  1913,  seemingly  re- 
flects, on  the  part  of  all  speakers,  a  neglect  of  the  economic  as  distinguished 
from  the  legal  concept: 

"Mr.  Meyer.  Having  the  value  of  the  physical  property,  which  is,  of 
course,  the  largest  task  in  the  ascertainment  of  the  different  elements  of 


160  RAILROAD  VALUATION 

But  the  economic  significance  is  the  same  in  either  case; 
and  there  is,  consequently,  no  present  responsibility  to 
attempt  classification  of  the  railroad  business  as  competi- 
tive or  monopolistic.  Good-will  depends  upon  the  assur- 
ance of  earnings;  so  does  "going  value,"  "connected 
value."  They  represent  the  same  kind  of  costs  (if  any) :  the 
expense  of  establishing  permanent  business  relations.  That 
in  the  one  case  poor  service  may  mean  a  loss  of  custom,  and 
that  in  the  other  no  usable  alternative  is  at  hand,  does  not 
destroy  this  fact  of  cost,  which,  for  our  purpose,  is  the 
significant  one.  Neither  good- will  nor  "going  value"  can 
here  be  measured  as  a  function  of  earning  power. 

Members  of  the  engineering  profession  have,  neverthe- 
less, used  a  capitalization  of  earning  power  to  determine 
upon  the  amount  of  the  "going  value."  But  their  process  of 
capitalization  is  a  very  complicated  one,  representing  the 
results  of  a  series  of  hypotheses  governed  entirely  by  "ex- 
pert" judgment.  In  the  first  place,  the  present  plant  is 
assumed  to  disappear,  a  new  "phantom"  plant,  without 
any  business,  being  erected  in  its  place.1  For  a  period 

value  that  enter  into  a  fair  valuation,  the  Commission  can,  when  neces- 
sary, inquire  into  the  other  elements  of  value.  What,  for  instance,  if  any- 
thing, shall  be  allowed  as  going  value? 

"I  assume  a  railway,  because  of  the  monopolistic  character  of  its  busi- 
ness cannot  claim  value  under  the  head  of  good-will,  as  a  gas  company 
might  conceivably,  but  I  believe  the  Supreme  Court  has  held  even  a  gas 
company  may  not  include  good- will  as  an  element  of  value;  but  such 
claims  have  been  made.  Now,  whatever  justice  there  may  be  in  such 
claims  is  a  matter  of  inquiry  in  each  specific  case. 

"The  Chairman.  A  company  having  an  absolute  monopoly  would 
have  more  good-will  than  anybody  else,  wouldn't  they? 

"Mr.  Meyer.  When  that  question  was  first  urged,  before  I  came  to 
Washington,  I  remember  asking  attorneys,  who  were  urging  it,  if,  in 
their  judgment,  regulating  authorities  would  consider  good-will  as  an 
asset,  whether  by  the  same  process  of  reasoning  they  should  not  also 
consider  ill-will  as  a  liability;  and  the  argument  was  not  pressed. 

"  Mr.  J.  A.  Martin.  On  that  basis  this  Washington  Traction  Company 
would  not  be  worth  anything,  if  I  was  valuing  it." 

Senate  Report  on  Valuation,  page  225. 

1  "Each  is  occupying  the  field  independent  of  the  other,  one  with  the 
business  and  the  other  without."  Testimony  of  President  Wheeler,  of  the 


INTANGIBLES  161 

(the  length  of  this  period  being  dependent  upon  the  will  and 
judgment  of  the  appraiser),  the  earnings  of  the  hypothetical 
plant  are  assumed  to  be  below  those  of  the  existing  plant. 
Then,  "the  sum  of  the  present  worths  of  the  annual  excess 
in  net  return"  received  by  the  existing  plant,  until  such 
time  as  the  earnings  of  the  comparative  plant  catch  up, 
"represents  the  amount  which  a  purchaser  could  afford  to 
pay  for  the  existing  property  with  its  established  income  in 
excess  of  the  value  of  its  bare  physical  plant "  (as  fixed  by 
appraisal).1 

Quite  aside  from  the  validity  of  the  premises,  a  discus- 
sion of  which  is  postponed  for  the  moment,  it  is  clear  that 
the  proposed  scheme  places  a  premium  on  conjecture.  And 
this  conjecture  is  in  a  field  where  there  is  no  possible  check 
through  even  the  roughest  measurement.  How  rapidly  will 
the  "phantom"  plant,  the  "comparative"  plant,  acquire 
earnings?  What  shall  be  the  rate  of  capitalization  for  de- 
termining the  "  present  worth  "  of  the  hypothetical  excess  in 
revenue?  How  great  will  be  the  annual  operating  expenses? 
etc.,  etc.2  The  man  who  would  presume  to  make  such  a  cal- 
culation for  an  American  railroad  system  would  prove  him- 
self truly  courageous.  The  scheme  can  only  be  described 
f*s  a  revelry  of  conjecture  which  presents  "expert  opinion" 
a  the  worst  possible  light. 

But  there  is  the  logical  bar  to  the  use  of  such  a  method 
of  calculation  when  rates  are  in  question.  The  revenue 
accrues  from  rates  already  in  effect,  and  there  can  be  no 

water  company,  Knoxville  0.  Knoxville  Water  Co.,  Record,  page  2138, 
212  U.S.  1. 

1  Leonard  Metcalf  and  John  W.  Alvord,  "The  Going  Value  of  Water 
Works,"  Transactions,  Am.  Soc.,  C.E.,  volume  73.    Discussed  at  length 
in  Whitten,  Valuation  of  Public  Service  Corporations,  chapter  xxiu,  pages 
500-19.  Mr.  Alvord  presented  computations  based  upon  these  hypotheses 
in  Green  Bay  v.  Green  Bay  Water  Co.,  12  W.R.C.R.  236;  and  in  Mil- 
waukee v.  Milwaukee  Gas  Light  Co.,  12  W.R.C.R.  441,  both  rate  cases. 

2  See  Milwaukee  v.  M.E.R.  &  L.  Co.,  10  W.R.C.R.  1,  152-53.  These 
two  pages  are  devoted  to  the  fourteen  hypotheses  involved  in  making  a 
"comparative  plant "  estimate  of  the  "going  value"  of  the  company.     - 


162  RAILROAD   VALUATION 

measure  of  reasonableness,  which  is  dependent  for  its 
amount  upon  the  level  of  charges.  It  is  extraordinary  that 
this  difficulty  has  appeared  "only  imaginary"  to  the 
expert  who  was  one  of  the  originators  of  the  scheme.1  But 
the  commissions  to  whom  the  calculations  on  this  basis 
have  been  presented,  have  usually,  but  not  always,  been  of 
another  mind.  And  rightly  so.2 

There  have  been  few  calculations  purporting  to  measure 
the  "going  value"  of  a  railroad.3  Nor  have  the  State 
appraisals  made  attempt  to  secure  such  figures.  The  rail- 
road attorneys  have  been  content  to  cite  the  conclusion  of 
Justice  Brewer  and  have  urged  that  "there  should  be 
added  something  in  addition  to  the  cost  of  reproducing  the 
property." 4  Their  aim  has  been  simply  to  set  the  "cost  of 

1  Benezette  Williams  and  C.  B.  Williams,  Report  to  the  Mayor  and  City 
Council  on  Water  Rates  for  Peoria,  Illinois,  page  27.  The  essentials  of  the 
"comparative  plant"  hypothesis  were  worked  out  by  the  former,  who 
persistently  talks  in  a  circle  when  discussing  the  subject.  See  quotations 
from  his  remarks  and  report  on  the  Peoria  situation,  in  WTiitten,  Valua- 
tion of  Public  Service  Comporations,  page  502  and  following.   The  reason 
why  the  difficulty  in  so  basing  "going  value"  is,  in  his  mind,  "imaginary," 
lies  in  the  assertion  that  the  "  discriminating  appraiser  can  determine  from 
the  revenue,  within  small  limits,  whether  the  rates  are  too  high  as  a  whole, 
to  give  a  proper  basis  for  computing  going  value,  and  he  can  always  cor- 
rect the  going  value  to  conform  to  the  proper  revenue  after  it  has  been 
determined."   Peoria  Report,  page  27;  Whitten,  page  512. 

2  See  Hill  v.  Antigo  Water  Co.,  3  W.R.C.R.  623,  716,  and  the  decisions 
outlined  in  Whitten,  Valuation  of  Public  Service  Corporations,  page  1280 
and  following  (volume  u).   It  would  seem  that  in  Milwaukee  v.  M.E.R. 
&  L.  Co.,  10  W.R.C.R.  1,  151-55,  159,  the  Wisconsin  Commission  did 
accord  serious  attention  to  the  scheme.  And  Former  Chairman  Erickson, 
in  an  address  before  the  Western  Society  of  Engineers,  failed  to  frown 
upon  a  use  of  the  "comparative  plant"  method:  "This  reproductive 
cost  and  the  actual  original  cost  of  the  business  can  then  be  compared, 
and  the  determination  of  the  going  value,  or  cost  of  the  business,  then 
depends  upon  the  exercise  of  a  sound  judgment,  based  upon  these  two 
costs."  Railway  Age  Gazette,  volume  54,  page  756.    (Italics,  the  writer's.) 

8  See  Montana,  Wyoming  &  Southern  R.R.  Co.  v.  Board  of  Railroad 
Commissioners,  198  Fed.  991,  apparently  the  exception. 

4  The  words  here  quoted  are  from  the  argument  of  Burton  Hanson, 
Evidence,  1910  Advances,  page  4286. 


INTANGIBLES  163 

reproduction  "  as  a  lower  limit.  These  tactics  were  pursued 
by  some  of  the  attorneys  for  the  railroads  in  the  1910 
Advance  Cases,1  and  by  the  railroad  counsel  in  the  Minne- 
sota Rate  Cases.2 

This  argument  has  been  supported  by  citations  from 
quite  another  series  of  decisions,  handed  down  during  the 
period  when  the  "valuation"  doctrine  was  unfolding  — 
opinions  also  written  by  Justice  Brewer.  In  Cleveland, 
Cincinnati,  Chicago  and  St.  Louis  Railway  Company  v. 
Backus,  the  "unit  rule"  of  taxation  was  developed.  The 
"value"  of  the  road  as  a  whole  was  determined,  and  the 
"value"  of  the  line  within  the  State  was  apportioned  on 
a  mileage  basis.3 

"The  true  value  of  a  line  of  railroad  is  something  more 
than  an  aggregation  of  the  values  of  separate  parts  of  it, 

1  Brief  of  Burton  Hanson  for  the  C.M.  &  St.P.,  Evidence,  1910  Ad- 
vances, page  3713;  Brief  of  C.  M.  Dawes  for  the  C.B.  &  Q.,  page  3635; 
Brief  of  G.  W.  Seevers  for  the  M.  &  St.L.,  page  3921.   See  also,  Brief  for 
the  Companies,  Minnesota  Rate  Cases,  page  334. 

The  argument  is  found  in  the  Brief  of  J.  M.  Woolworth  for  the  Com- 
panies in  Smyth  v.  Ames  (169  U.S.  466),  page  58. 

2  Here  it  was  stated  "as  a  rule"  that  the  true  value  of  a  property 
"efficiently  located,  constructed,  and  maintained,"  where  the  results  of 
operations  "show  volume  of  traffic  and  earnings  sufficient  to  support 
the  property,  pay  reasonable  dividends,  and  leave  something  in  addi- 
tion, is  in  excess  of  the  mere  cost  of  reproduction  of  the  physical  or 
tangible  property." 

Brief  for  the  Companies,  Minnesota  Rate  Cases,  page  160.  This  "  rule " 
was  supported  by  a  series  of  citations  from  tax,  condemnation,  and  rate 
decisions,  of  which  only  three  (Smyth  v.  Ames,  Knoxville  v.  Knoxville 
Water  Co.,  and  Willcox  v.  Consolidated  Gas  Co.)  were  Supreme  Court 
decisions.  There  is  nothing  in  these  cases  as  decided  to  warrant  the  un- 
qualified statement  of  the  "rule."  The  attorneys  might  have  said,  with 
equal  truth,  that  the  value  (i.e.,  exchange  value,  which  they  apparently 
had  in  mind)  bore  no  relation  whatever  to  anything  but  earnings,  realized 
and  prospective. 

See  the  testimony  of  W.  L.  Darling,  Minnesota  Rate  Cases,  Record 
(N.P.),  pages  29-30;  that  of  Howard  Elliott,  page  1257  and  following; 
and  of  J.  J.  Hill,  Record  (G.N.),  page  1290. 

3  See  above,  page  18,  describing  the  "process"  of  the  Indiana  Tax 
Commission  in  fixing  upon  the  value  of  the  road  as  a  whole. 


164  RAILROAD  VALUATION 

operated  separately.  It  is  the  aggregate  of  those  values  plus 
that  arising  from  a  connected  operation  of  the  whole,  and 
each  part  of  the  road  contributes  not  merely  the  value  arising 
from  its  independent  operation,  but  its  mileage  proportion 
of  that  flowing  from  a  continuous  and  connected  operation 
of  the  whole.  This  is  no  denial  of  the  mathematical  proposi- 
tion that  the  whole  is  equal  to  the  sum  of  all  its  parts,  because 
there  is  a  value  created  by  and  resulting  from  the  combined 
operation  of  all  its  parts  as  one  continuous  line." 

And  to  make  more  certain  his  meaning,  Justice  Brewer 
gave  the  illustration  of  the  formation  of  the  New  York 
Central  Railroad: 

"Immediately  upon  the  consolidation  .  .  .  the  value  of 
the  property  was  recognized  in  the  market  as  largely  in  excess 
of  the  aggregate  of  the  values  of  the  separate  properties."  l 

But  Justice  Brewer  was  speaking  of  market  value,  and  the 
increase  in  this  value  could  only  come  through  a  realized, 
or  anticipated,  increase  in  net  earnings,  or  through  a 
change  in  the  rate  of  capitalization.  Indeed,  his  language 
had  no  connection  whatever  with  "value"  as  determined 
by  appraisal.  Because  of  a  parallel  in  phraseology,  counsel 
have  apparently  attempted  to  correlate  opinions  upon  quite 
detached  subjects.2 

"After  much  discussion,  comparison  of  figures,  and 
readjustment,"  the  Court  in  the  National  Water  Works 
Case  fixed  upon  $3,000,000  as  the  "fair  and  equitable 
value  "  which  should  be  paid  by  the  city.  This  was  "  some- 

*  154  U.S.  439,  444. 

In  Adams  Express  Co.  v.  Ohio  (also  a  taxation  case)  Justice  Brewer 
wrote  in  similar  vein:  "Now,  whenever  separate  articles  of  tangible  prop- 
erty are  joined  together,  not  simply  by  a  unity  of  ownership,  but  in  a 
unity  of  use,  there  is  not  infrequently  developed  a  property,  intangible 
though  it  may  be,  which  in  value  exceeds  the  aggregate  of  the  value  of 
the  separate  pieces  of  tangible  property."  166  U.S.  185,  219. 

See  A.T.  &  S.F.  Ry.  Co.  v.  Sullivan,  173  Fed.  456,  464. 

2  Brief  for  the  Companies,  Minnesota  Rate  Cases,  pages  334-35;  Brief 
of  Burton  Hanson,  Evidence,  1910  Advances,  page  3714;  Brief  of  Messrs. 
Dunlap,  Norton  and  Lathrop,  pages  3601,  3603;  and  the  Valuation  Brief 
of  1015,  pages  494-96. 


INTANGIBLES  165 

thing  in  excess  of  the  cost  of  reproduction"  (which  by 
appraisal  had  been  placed  at  $2,714,000);  but  the  addi- 
tional $286,000  represented  simply  an  arbitrary  allowance. 
No  reason  appears  in  the  decision  to  indicate  why  the 
figure  was  not  placed  above  (or  below)  that  chosen,  except 
perhaps  that  $3,000,000  was  the  par  of  a  bond  issue.1  That 
the  Court  had  any  clean-cut  conception  of  the  nature  of 
this  "value  which  flows  from  the  established  connections" 
is  doubtful.  The  conclusion  was  simply  that  the  city  was  to 
secure  a  property  which  not  only  had  "  the  pledge  to  earn," 
but  was  "in  fact  earning."  The  argument  is,  then,  quite 
typical  of  the  reasoning  on  the  subject  of  "value"  found 
in  the  judicial  opinions.  Certainly  there  is  nothing  to 
indicate  that  Justice  Brewer  had  in  mind  what  may  be 
called  the  "cost  of  production"  of  a  "going  business."  2 

Nor  has  there  been  unanimity  among  the  "experts,"  or 
even  clarity,  either,  for  that  matter.  What  could  be  more 
noncommittal  than  the  assertion  that  "  going  value  "  in- 
cluded "practically  all  the  elements  of  value  which  the 
company  may  possess  outside  of  its  actual  structural  value, 
and  the  tangible  worth  of  value  of  its  quick  assets"?  This 
product  of  a  "very  wide  expert  experience"  impressed  the 
New  Jersey  Commission  with  its  "solidity."  3  Or  there  is 
the  definition  of  M.  E.  Cooley,  who  speaks  of  "the  value 
lying  in  the  property  by  virtue  of  its  kinetic  or  dynamic 
character,  as  distinguished  from  the  value  in  the  property 
by  virtue  of  its  potential  or  static  character."  4  One  is 
forced  to  the  opinion  that  the  idea  of  value  as  something 
independent  of  earnings  is  by  no  means  confined  to  the 
members  of  the  legal  profession. 

The  method  of  measurement  (other  than  the  "compara- 

1  National  Water  Works  Co.  v.  Kansas  City,  62  Fed.  853,  866. 

2  Ibid.,  page  865. 

«  In  re  Rates,  Public  Service  Gas  Co.,  1  N.J.B.P.U.C.  433,  477.  This 
definition  had  been  asked  for  "as  a  definition." 

4  Milwaukee  v.  M.E.R.  &  L.  Co.,  10  W.R.C.R.  1,  151.  Professor 
Cooley  appeared  as  an  "expert"  witness  for  the  company. 


166  RAILROAD  VALUATION 

tive  plant"  method)  proposed  by  the  "experts,"  has  gener- 
ally been  the  safe  method  (safe,  since  devoid  of  principle)  of 
measuring  the  allowance  for  the  "going  concern"  in  terms 
of  a  percentage  of  the  "value"  of  the  plant  as  determined 
by  appraisal.1  For  the  present  purpose  it  is  sufficient  to 
cite  a  single  instance.  In  one  Wisconsin  Commission  case, 
the  two  experts  for  the  company  placed  this  figure,  one  at 
ten  per  cent,  the  other  at  twenty  per  cent.2  Had  another 
set  of  experts  been  at  hand  the  figures  could  have  been 
placed  at  fifteen  per  cent 3  —  at  thirty  per  cent;  even  at 
one  third  the  "structural  value."4  Resort  to  such  rough 
approximation  (based  on  no  logical  relationship)  can 
hardly  set  claim  to  being  a  serious  contribution  to  the 
problem  of  regulation.5 


IV 

The  Wisconsin  Commission  has,  however,  invoked  what 
it  has  called  a  doctrine  of  "cost,"  having  as  a  major 
premise  the  assumption  that  the  company  in  the  public 
service  is  "entitled"  to  the  same  "fair  return v  from  the 

1  The  failure  of  the  Minnesota  Master  to  deduct  "depreciation"  was 
justified  in  part  on  the  grounds  of  "adaptation  to  the  needs  of  the  coun- 
try," "knowledge  derived  from  experience,"  and  "readiness  to  serve," 
marking  his  acceptance  of  testimony  of  J.  J.  Hill,  Minnesota  Rate  Cases, 
Record  (G.N.),  page  1299;  of  Howard  Elliott,  Record  (N.P.),  page  1249. 
See  Minnesota  Rate  Cases,  230  U.S.  352,  457-58. 

2  Milwaukee  ».  M.E.R.  &  L.  Co.,  10  W.R.C.R  1,  157. 

«  Knoxville  v.  Knoxville  Water  Co.,  212  U.S.  1,  Record,  page  2137. 
Here  the  president  of  the  company  attempted  to  justify  the  figure  of 
fifteen  per  cent  which  rested  "very  largely"  on  his  judgment,  as  a 
"single,  convenient .  .  .  conservative  basis." 

4  See  State  Journal  Printing  Co.  v.  Madison  G.  &  E.  Co.,  4  W.R.C.R. 
501,  571,  an  amusing  comment  on  the  testimony  of  President  Hum- 
phreys, of  Stevens  Institute,  who  testified  as  an  "expert."  He  testified 
with  equal  vagueness,  but  in  a  positive  tone,  in  the  New  York  Gas  Case, 
Record,  pages  1688-89,  Willcox  v.  Consolidated  Gas  Co.,  212  U.S.  19. 

6  In  Pioneer  T.  &  T.  Co.  v.  Westenhaver,  the  Oklahoma  Supreme 
Court  accepted  one  of  these  expert  "opinions,"  which  was  "not  contra- 
dicted by  the  State."  118  Pacific  354,  361. 


INTANGIBLES  167 

beginning  of  its  operations.  The  general  experience  of  new 
enterprises  shows  during  the  preliminary  years  of  opera- 
tion a  return  less  than  the  normal  going  rate  on  invest- 
ments in  established  enterprises.  Does  not  the  sum  of 
these  "deficits"  measure  "the  cost  of  building  up  the 
business"?  l  The  Wisconsin  Commission  has  so  assumed; 
and  this  "continuous  property"  theory  is  one  of  the  work- 
ing tools  of  that  body,  its  use  now  justified  by  reference  to 
precedent.2  Professor  J.  R.  Commons,  appearing  before 
the  Senate  Committee  working  upon  the  Valuation  Bill, 
could  testify  at  length  in  its  favor.3 

The  same  general  line  of  thought  is  found  in  Commis- 
sioner Lane's  opinion  in  the  Western  Advance  Case  of  1910, 
where  he  broke  from  the  "rule"  in  Smyth  v.  Ames,  which 
Commissioner  Prouty  used  as  the  guide  for  his  discussion 
in  the  Eastern  Case.  In  summing  up,  Mr.  Lane  said: 

"  The  nearest  approximation  to  the  fair  standard  is  that  of 
bona  fide  investment  —  the  sacrifice  made  by  the  owners  of  the 
property  —  considering  as  part  of  the  investment  any  shortage  of 
return  that  there  may  be  in  the  early  years  of  the  enterprise.  Upon 
this,  taking  the  life  history  of  the  road  through  a  number  of 
years,  its  promoters  are  entitled  to  a  reasonable  return."  * 


1  See  Metropolitan  Trust  Co.  v.  H.  &  T.C.R.  Co..  90  Fed.  683,  687, 
possibly  the  original  source  of  inspiration. 

8  This  doctrine  was  first  clearly  expressed  in  Hill  v.  Antigo  Water  Co., 
3  W.R.C.R.  623,  711  (1909).  See  Milwaukee  v.  M.E.R.  &  L.  Co.,  10 
W.R.C.R.  1,  122,  and  cases  there  cited.  In  Spring  Valley  W.W.  ».  San 
Francisco,  124  Fed.  574  (1903),  a  similar  calculation  had  been  introduced 
by  the  company,  page  577;  also,  165  Fed.  667,  696;  192  Fed.  137,  166. 

1  Senate  Report  on  Valuation,  pages  94  and  99.  See  testimony  of  B.  H. 
Meyer,  before  the  House  Committee,  ibid.,  pages  225  and  228. 

*  Western  Advance  Case  of  1910,  20  I.C.C.  307,  347.  The  italics  are 
the  writer's. 

The  Antigo  Case,  though  not  referred  to  by  Commissioner  Lane,  was 
cited  in  the  Brief  of  Messrs.  Dunlap,  Norton  and  Lathrop  for  the  Santa 
F6.  Evidence,  1910  Advances,  pages  3567,  3609.  The  attorneys  for  the 
State  in  the  Minnesota  Rate  Cases,  seeking  to  throw  discredit  on  the 
"cost  of  reproduction,"  quoted  the  passage  in  Commissioner  Lane's 
opinion.  Brief  for  the  State,  page  80. 


168  RAILROAD  VALUATION 

The  Atchison,  Topeka  and  Santa  Fe  was  the  only 
carrier  which  presented  figures  purporting  to  measure  this 
"shortage  of  return."  The  late  Mr.  James  Peabody,  the 
company's  Statistician, testified  that  since  1896,  when  the 
company  was  reorganized,  this  amount  had  grown  to 
$154,568,319.69.  These  figures  had  been  worked  out  by  his 
chief  clerk  in  "two  or  three  hours,"  and  were  introduced 
under  the  formidable  caption,  "account  current  of  the 
A.T.  &  S.F.  Ry.  Co.  with  the  public  on  the  basis  of  6  per 
cent  return  on  the  property  investment."  l  Since  this 
table  was  presented  with  all  the  completeness  of  a  "  cost  of 
reproduction"  estimate,  it  is  worth  while  to  indicate  the 
process  by  which  the  pretentiously  accurate  total  was 
determined. 

The  calculations  began  with  the  "property  investment 
of  January  1, 1896,"  as  shown  on  the  books  of  the  reorgan- 
ized corporation.  This  original  figure  was  $371,669,326.78. 
To  this  was  added  one  half  of  the  cost  of  the  additions 
made  during  the  first  six  months  of  operation,  proce- 
dure entailed  because  of  the  non-coincidence  of  calendar 
and  fiscal  year.  The  total  was  a  "mean  investment" 
of  $371,886,794.77.  Three  per  cent  of  this  total  was 
$11,156,603.84;  the  "income  available  for  return  on  in- 
vestment" was  only  $2,432,870.06.  Therefore  a  "defi- 
ciency in  return  to  be  carried  to  investment"  appeared  of 
$8,723,733.78.  The  "total  investment  at  the  end  of  fiscal 
year"  was  consequently  the  sum  of  this  "deficit,"  the 
original  "total  investment,"  and  the  total  cost  of  addi- 
tions. To  this  amount  was  added  one  half  the  cost  of 
improvements  made  in  the  next  fiscal  year,  etc.,  and  the 
train  of  calculations  was  duly  concluded  to  1911.  A  series 
of  "deficits"  resulted,  ranging  from  nearly  five  million  dol- 
lars, in  the  boom  year,  1906-07,  to  seventeen  millions  in 
the  first  full  year  of  operation  (1896-97).  Even  in  1910  the 

1  Evidence,  1910  Advances,  pages  1107.  1108,  1098,  5563,  Exhibit 
No.  26-8. 


INTANGIBLES  169 

amount  ran  above  ten  millions.  Over  the  period  of  years 
"the  deficiency  in  return  to  be  carried  to  investment" 
amounted  to  the  exact  total  which  was  presented  to  the 
Commission  —  $154,568,319.69. l 

The  first  concern  is  with  the  statistical  adequacy  of  this 
calculation.  It  began  with  an  item,  the  Investment  account 
of  the  reorganized  company,  which,  if  not  in  some  degree 
fictitious,  was  of  uncertain  validity.  To  balance  the  in- 
creased par  of  securities,  it  had  been  "written  up  "some 
$40,000,000  without  any  additions  to  physical  assets.2 
How  much  or  how  little  the  total  represented  "water"  be- 
fore that  time  is  entirely  conjectural. 

In  the  second  place,  had  the  income  been  accurately 
stated  during  the  period ;  was  the  property  being  "  milked  " ; 
or,  what  is  more  probably  true,  were  net  additions  being 
made  out  of  earnings?  If  so,  to  what  extent  had  the 
"  squeezing-out "  process  been  operative  in  any  one  year? 
These  questions  obviously  cannot  now  be  answered. 
Yet  on  the  basis  of  figures  which  were,  on  this  ground, 
quite  inconclusive,  an  "account  current"  against  the 
public  was  drawn  up,  which  one  of  the  foremost  railroad 
statisticians  of  the  country  declared  "was  made  out  in 
harmony"  with  his  views.3  The  truth  is  simply  that  the 

1  Evidence,  1910  Advances,  pages  1098,  5563. 

Mr.  Peabody  here  spoke  of  this  as  the  amount  "that  the  public  owe 
the  Santa  Fe  road  on  the  basis  of  six  per  cent  return  on  property  in- 
vestment;" the  Brief  for  the  company,  as  the  "absolute  inadequacy  of 
earnings,"  page  3567. 

The  detailed  method  used  by  the  Wisconsin  Commission  is  described 
in  full  in  State  Journal  Printing  Co.  t>.  Madison  G.  &  E.  Co.,  4  W.R.C.R. 
501,  580.  The  same  general  hypotheses  are  there  used,  as  those  assumed 
by  Mr.  Peabody. 

2  See  the  detailed  discussion  of  Santa  Fe  accounting  methods  prior  to 
the  administration  of  President  Ripley,  W.  M.  Cole,  Accounts,  page  196. 
Mr.  Peabody  testified  that  he  made  "no  analysis  of  the  original  amount 
whatever,"  Evidence,  1910  Advances,  page  1107. 

8  Evidence,  1910  Advances,  page  1107.  Nor  have  the  computations  made 
by  the  Wisconsin  Commission&een  more  scientific.  Rejecting  book  accounts 
and  reverting  to  the  meaningless  "average  price"  appraisal,  it  has  never- 


170  RAILROAD   VALUATION 

computation  is  an  example  of  worthless  statistical  pro- 
cedure. 

An  equally  compelling  criticism  can  be  brought  against 
the  validity  of  another  of  the  premises.  Why  should  the 
rate  of  six  per  cent  be  used  instead  of  eight,  or  nine,  or  ten 
per  cent?  l  The  rate  of  six  per  cent  may  have  represented 
simply  gravitation  to  a  rate,  which,  at  least,  in  the  public 
mind,  bears  the  earmarks  of  "fairness."  At  all  events,  the 
Wisconsin  Commission's  computations  have  usually  been 
based  upon  higher  rates,  seven  and  seven  and  a  half  per 
cent,  not  infrequently  eight.2 

That  in  a  business  involving  a  greater  or  less  degree  of 
risk  (the  extent  of  risk  is  not  our  present  concern)  such  rates 
might  well  not  be  excessive  may  be  granted  at  once.3  But 
though  the  Wisconsin  scheme  as  applied  by  the  Santa  Fe 
would  not  insist  on  payment  out  of  hand  to  the  stock- 

theless  used  these  same  accounts  in  order  to  measure  the  "cost  of  build- 
ing up  the  business."  And  the  totals,  like  those  of  Mr.  Peabody,  have 
been  presented  as  though  accurate  to  the  final  cent.  See  Milwaukee  v. 
M.E.R.  &  L.  Co.,  10  W.R.C.R.  1,  151;  and  cases  cited  at  page  123. 

Though  Mr.  Peabody  assumed  sole  responsibility  for  his  figures,  it 
would  seem  that  G.  O.  May,  an  accountant  who  testified  for  the  Santa 
Fe",  may  have  been  the  one  suggesting  the  compilation  of  the  table.  Evi- 
dence, 1910  Advances,  page  1052. 

1  "Mr.  Peabody.  .  .  .  The  public  owe  the  Santa  Fe  Road  .  .  .  $154,- 
568,319.69. 

"  Mr.  Norton.  And  that  amount  would  be  much  larger  if  it  was  com- 
puted at  eight  or  nine  or  ten  per  cent? 

"  Mr.  Peabody.  If  it  was  a  larger  per  cent,  the  amount  would  be  very 
much  larger." 

Evidence,  1910  Advances,  page  1098. 

2  In  the  Antigo  Case,  which  was  the  precedent  to  which  the  Santa  Fe" 
attorneys  looked,  one  set  of  calculations  was  made  on  the  six  per  cent 
basis;  another  set  on  the  seven  per  cent  basis.    3  W.R.C.R.  623,  744-50. 
See  In  re  Menominee  &  Marinette  L.  &  T.  Co.,  3  W.R.C.R.  778,  792; 
State  Journal  Printing  Co.  v.  Madison  G.  &  E.  Co.,  4  W.R.C.R  501, 
577;  City  of  Appleton  v.  Appleton  W.W.  Co.,  5  W.R.C.R.  215,  276; 
Cunningham  et  al.  v.  Chippewa  Falls  W.  &  L.  Co.,  5  W.R.C.R.  302,  315. 

3  It  should  be  noted  that  where  a  portion  of  the  funds  invested  are 
secured  by  bonds  bearing  a  lower  rate  than  the  rate  on  which  the  calcu- 
lations are  made,  the  result  is  to  increase  the  rate  of  return  on  the  invest- 
ment by  shareholders. 


INTANGIBLES  171 

holders  of  fifteen  years  ago,  it  would,  in  substance,  permit 
them  (or  the  persons  to  whom  they  have  sold)  to  consider 
the  "  deficits  "  as  investment.  In  other  words,  these  stock- 
holders are  placed  in  exactly  the  same  position  as  the  in- 
vestor whose  enterprise  began  as  an  immediate  success, 
who  received  dividends,  made  savings,  and  reinvested  in 
this  or  in  another  enterprise.1  The  compounding  of  annual 
"deficits"  perhaps  stops  short  of  a  formal  guarantee  of 
return  to  the  company.  But  in  effect  one  risk  element  is 
removed:  there  can  be  no  legislation  affecting  rates  un- 
less previous  "deficits"  are  included  as  "investment." 

A  corollary  of  the  proposal  to  "capitalize  the  deficit" 
says:  "the  surplus  should  be  deducted."  This,  at  least,  is 
the  doctrine  to  which  Professor  Commons  subscribed.2 
The  issue  was  raised  in  the  Spokane  Case.  The  counsel  for 
the  city  insisted  that  the  "physical  value"  should  be  re- 
duced by  the  amount  of  the  accumulated  surplus.  In  the 
face  of  the  dividends  paid,  its  existence  indicated,  they 
declared,  that  excessive  rates  had  been  charged.  The  rail- 
road is  an  agent  of  the  Government,  and  as  such  is  entitled 
only  to  "reasonable  compensation."  This  the  dividends 
had  constituted.  Therefore  the  surplus  represented  exploi- 
tation, and  its  amount  should  be  conceived  of  as  a  fund 
held  by  the  railroad  as  trustee  for  the  public.  So  ran  the 
indictment  and  the  argument.  In  refusing  to  approve  this 

1  The  fact  that  a  former  holder  made  this  "investment"  (entirely 
unconsciously  since  the  Antigo  scheme  is  a  modern  invention)  does  not 
change  the  character  of  this  conclusion.    On  the  contrary,  the  former 
holder  sold,  and  bore  the  loss,  the  present  holder  purchasing  for  the  in- 
come of  the  future.    To  him  the  bonus  accrues  as  a  gratuity.  But  if  the 
fact  that  "deficits"  were  incurred  under  other  than  present  owners,  and 
borne  by  them,  is  to  constitute  a  bar  to  such  allowance,  because  the  "def- 
icits" have  "been  wiped  out  in  the  various  transfers  of  ownership,"  the 
claim  would  seem  in  a  precarious  state.    See  State  Journal  Printing  Co. 
v.  Madison  G.  &  E.  Co.,  4  W.R.C.R.  501,  586,  where  the  point  is  raised. 

2  Senate  Report  on  Valuation,  pages  100, 130,  where  the  phrases  quoted 
appear;  also  pages  127-30. 


172  RAILROAD   VALUATION 

reasoning  the  Commission  indicated  points  of  insufficiency. 
In  the  first  place  the  Government  had  supplied  no  absolute 
test  of  a  reasonable  rate;  in  the  second  place,  accumulation 
of  a  surplus  by  a  particular  road  might  be  accounted  for  by 
reason  of  "cheaper  construction  and  easier  operation."  l 
The  fact  that  the  company  had  the  choice  of  distributing 
the  income  to  its  owners  as  dividends,  but  instead  chose  to 
add  to  its  plant  (in  short,  forced  the  shareholders  to  add 
to  their  investment  in  the  railroad,  rather  than  allowing 
them  to  invest  elsewhere),  the  opinion  did  not  consider; 
though  this,  it  would  seem,  should  be  the  vital  issue.  That 
the  "saving"  had  been  done  by  a  corporation,  rather  than 
by  individuals,  should  not  hide  the  economic  significance 
of  the  omission  to  distribute  the  volume  of  earnings.  The 
risk  was  assumed;  the  venture  proved  profitable;  part  of 
the  earnings  were  put  back  into  the  property.2  Certainly  to 

1  Spokane  v.  N.P.  Ry.  Co.,  15  I.C.C.  376,  410,  415.  See  Commissioner 
Lane's  discussion  in  the  Western  Advance  Case  of  1910,  20  I.C.C.  307. 
The  arguments  of  the  attorneys  for  the  city  of  Spokane  were  similar  to 
those  used  by  E.  B.  Whitney  in  Willcox  v.  Consolidated  Gas  Co.,  212 
U.S.  19.    Mr.  Whitney's  Brief  reads  as  follows:  "Properties  purchased 
out  of  surplus  earnings,  over  and  above  high  dividends,  the  facts  not 
being  disclosed  to  the  consumer,  should  be  regarded  as  having  been 
contributed  by  the  consumer,  and  not  by  the  company,  and  hence  should 
not  be  treated  as  capital  for  the  purpose  of  fixing  rates"  (page  244). 
This  reasoning  is  called  "socialistic"  by  J.  M.  Beck,  in  his  Brief  (page 
100),  though  Mr.  Whitney  in  his  reply  insisted  that  to  hide  "further  prof- 
its which  the  public  does  not  know  that  it  is  making,  by  paying  them 
out  in  what  the  public  believe  to  be  operating  expenses,  but  which  are 
really  additional  construction,  the  purpose  of  the  whole  thing  being  to 
prevent  the  public  from  knowing  how  much  money  the  company  is  really 
making,  and  then  capitalize  this  additional  construction  against  the 
public,  and  collect  tolls  thereon  for  the  rest  of  eternity"  meant  "the 
permanent  capitalization  of  an  original  fraud  "  (pages  47-48). 

See  Evidence,  1910  Advances,  page  4338,  Argument  of  L.  D.  Brandeis; 
and  page  5288,  that  of  Walker  D.  Hines  in  reply;  where  both  men  assert 
that  high  earnings  do  not  necessarily  indicate  "excessive  rates." 

2  This  problem  has  never  come  to  the  Supreme  Court  as  an  issue.  In 
Louisiana  Railroad  Commission  v.  Cumberland  T.  &  T.  Co.,  212  U.S. 
414,  425,  Justice  Peckham,  though  discussing  the  property  presumably 
representing  reinvestment  of  the  charges  to  depreciation,  indicated  that 
the  Court  was  not  "considering  a  case  where  there  are  surplus  earnings 


INTANGIBLES  173 

declare  at  this  time  that  the  "surplus"  accumulated  in  the 
past  represents  extortion,  and  that  extensions,  etc.,  in 
effect  offset  on  the  balance-sheet  by  the  "  surplus,"  should 
not  be  considered  as  investment  by  the  company  for  the 
benefit  of  its  owners,  but  instead  as  a  "trust  fund"  for  the 
public,  involves  a  very  real  regulation  (confiscation?)  of 
"past  profits."  The  company  which  has  conserved  its 
resources  would  be  penalized  for  careful  management.  But 
if  the  successful  railroad  shall  keep  the  fruits  of  its  extraor- 
dinary gains,  the  unsuccessful  must  expect  to  bear  its 
losses.  Such  consistent  application  of  the  reasoning  has  not, 
however,  been  required  by  the  attorneys  for  the  railroads. 
The  one  has  insisted  that  the  past  "losses"  should  in  effect 
be  capitalized.  His  colleague,  representing  another  interest, 
has  vigorously  protested  against  a  deduction  on  account  of 
earnings  made  in  excess  of  a  "fair  return."  "  Heads  we  win, 
but  tails,  you  lose."  1  And  all  this,  be  it  remembered, 
assumes  that  the  surplus  is  real. 

It  is  easy  enough  to  reduce  to  an  absurdity  the  pro- 
gramme which  would  conceive  of  "deficits"  as  "invest- 
ment." The  more  unsuccessful  a  project  has  been,  the 
greater  has  been  "the  cost  of  building  up  the  business"; 

after  providing  for  a  depreciation  fund,  and  the  surplus  is  invested  in  ex- 
tensions and  additions."  That  problem  could  be  dealt  with  as  it  might 
arise.  See  also  Whitten,  Valuation  of  Public  Service  Corporations,  page 
176  and  cases  cited.  Mr.  Whitten  writes:  "If  a  company  has  charged 
rates,  not  alone  adequate  to  pay  a  fair  and  reasonable  profit  to  the  stock- 
holders, .  .  .  but  also  to  permit  the  building  out  of  earnings  of  exten- 
sions, there  is  some  justice  in  the  argument  that  unless  this  has  been 
done  for  the  benefit  of  consumers  it  represents  pure  extortion." 

See  the  Valuation  Brief  of  1915,  pages  472-78. 

1  Brief  of  Messrs.  Dunlap,  Norton  and  Lathrop,  for  the  Santa  Fe,  Evi- 
dence, 1910  Advances,  page  3609;  that  of  C.  M.  Dawes  for  the  C.B.  &  Q., 
page  3634;  that  of  E.  M  Hyzer  for  the  C.  &  N.  W..  pages  3751-54;  and 
argument  of  Walker  D.  Hines,  page  5289. 

The  Wisconsin  Commission,  when  a  "negative"  figure  would  develop, 
has  been  content  to  indicate  that  no  "going  value"  should  be  allowed. 
See  State  Journal  Printing  Co.  v.  Madison  G.  &  E.  Co.,  4  W.R.C.R.  501, 
582,  583.  Clearly  this  is  a  failure  to  face  the  logical  issue. 


174  RAILROAD  VALUATION' 

the  greater  is  its  "value "  as  a  going  concern.  A  protracted 
preliminary  deficit  might,  in  the  long  run,  be  as  substantial 
a  goal  for  efficient  management  (in  the  sense  that  the  test 
of  management  is  the  securing  of  returns  for  the  owners) 
as  an  unbroken  record  of  dividend  payments,  or  the 
creation  of  a  surplus.  But  Commissioner  Lane  qualified 
his  approval  of  the  doctrine  that  a  "shortage  of  return" 
be  considered  as  "bonafide  investment."  Such  conclusion 
"manifestly"  is  limited;  for  a  return  should  not  be  given 
upon  wastefulness,  mismanagement,  or  poor  judgment.1 
The  Wisconsin  Commission  has  held  that  "deficits  due  to 
abnormal  conditions,  bad  management,  poor  judgment, 
extravagance,  lack  of  ordinary  care  and  foresight  .  .  . 
should  receive  very  little  attention."  2  Professor  Commons 
insisted  that  "the  deficit  must  be  reasonable."  3 

These  qualifications  are  obviously  more  plausible  than 
capable  of  practical  use.  They  assume  the  existence  of  a 
"representative  firm"  with  "reasonable"  and  honest 
direction.  But  what  test  shall  be  applied  to  determine 
"slipshod,  careless,  unprogressive  management"  of  a 
generation  ago;  what  of  "competition";  "the  collapse  of 
the  boom "?  4  The  one  convincing  test  is  the  very  ability  or 
inability  of  the  venture  to  net  its  owners  the  normal  return 
which  might  have  accrued  from  investment  in  another 
direction,  assuming  that  its  operations  have  not  been 
squeezed  or  irrationally  hampered  by  restrictive  legislation. 

Whether  in  condemnation  proceedings,  after  the  investor 
has  borne  a  deprivation  of  income  accruing  during  the 

1  Western  Advance  Case  of  1910,  20  I.C.C.  307,  347. 

2  State  Journal  Printing  Co.  v.  Madison  G.  &  E.  Co.,  4  W.R.C.R. 
501,  586,  also  Superior  Commercial  Club  v.  Superior  W.L.  &  P.  Co.,  10 
W.R.C.R.  704,  742. 

8  Senate  Report  on  Valuation,  page  95. 

4  See  Application  Oconto  City  Water  Co.,  7  W.R.C.R.  497,  516; 
Application  La  Crosse  G.  &  E.  Co.,  8  W.R.C.R.  138,  184;  Superior 
Commercial  Club  v.  Superior  W.L.  &  P.  Co.,  10  W.R.C.R.  704,  742;  in 
which  these  points  are  raised. 


INTANGIBLES  175 

first  years  of  operation,  allowance  might  not  equitably 
be  made  for  "deficits"  presents  entirely  different  con- 
siderations from  those  which  are  presented  when  rates 
of  charge  are  concerned.  Condemnation  deprives  the 
enterprise  of  the  power  to  make  such  profits  through  a 
period  of  years  as  had  been  contemplated  when  the  invest- 
ment was  first  made.  There  can  be  valid  reason  for  the 
allowance  in  the  one  case,  and  not  in  the  other.  Rate  regu- 
lation does  not  contemplate  taking  the  property  from  the 
owner.  What  is  a  "fair  return"  depends  upon  the  risk 
assumed,  and  the  degree  of  skill  and  judgment  exercised  in 
planning  the  enterprise.  The  normal  return  must  accrue 
in  the  "representative  case"  —  the  case,  indeed,  where  it 
would  seem  the  Wisconsin  Commission  and  Mr.  Lane  have 
sought  to  apply  the  "  deficit "  theory. 

The  fundamental  error  of  principle  in  the  Wisconsin 
doctrine  is  that  it  seeks  to  measure  an  "investment,"  not 
in  terms  of  "saving,"  of  effort,  of  sacrifice,  but  by  results. 
It  has  been  insisted  that  "going  value,"  as  calculated  on 
the  "deficit"  plan,  is  a  "true  cost";  that  "it  is  a  true  in- 
vestment on  the  part  of  the  owners"  —  "an  investment 
in  the  sense  that  the  company  might  have  invested  its 
money  in  other  business  which  would  have  given  it  a 
fair  rate  of  return."  l  Passing  over  this  matter  of  fact 
assumption  of  a  justum  pretium  assured  to  investors  out- 
side of  the  railroad  business  (how  this  insurance  operates 
is  left  unsaid),  does  the  sense  here  attached  to  the  word 

1  J.  R.  Commons,  Senate  Report  on  Valuation,  page  94:  "Now,  notice 
that  this  involves  the  addition  of  an  intangible  value,  not  based  on  future 
earning  power  like  a  franchise  or  good-will,  but  based  on  a  past  invest- 
ment or  cost,  as  compared  with  other  investments;  that  is,  not  only 
what  they  actually  paid  for  cost  of  construction  is  investment,  but  the 
income  they  could  have  secured,  but  did  not  secure,  in  comparison  with 
others  who  received  a  fair  return,  is  also  a  cost,  and  therefore  an  invest- 
ment." 

This,  like  the  passage  quoted  in  the  text,  overlooks  entirely  the  risk- 
assuming  function. 


176  RAILROAD  VALUATION 

"investment"  accord  with  economic  usage,  or  current 
economic  reasoning?  Investment  requires  saving,  the 
putting  aside  of  income,  and  its  subsequent  use  in  produc- 
tion. Is  any  saving  involved  in  the  "deficit"  theory?  On 
the  contrary,  it  would  measure  investment  in  terms  of  a 
failure  to  earn,  in  terms  of  a  failure  to  provide  a  source  of 
investment.  No  choice  of  spending  or  saving  appears. 
There  is  only  assumption  of  investment,  with  nothing  to 
invest;  of  sacrifice,  with  nothing  to  forego.  The  hardship 
outlined  by  referring  to  an  assured  "fair  return"  (what- 
ever that  may  mean)  from  investment  in  another  direction 
which  did  not  accrue  from  the  investment  in  a  railroad  is 
not  real.  There  is  no  assurance  in  any  business  of  a  "fair" 
(meaning  here  a  "normal,"  or  "representative")  return. 
Risks  are  assumed,  with  the  expectation  that  in  the  long  run 
the  return  received  will  compensate  the  investor.  There 
are  failures,  as  well  as  successes,  in  any  line  of  business 
activity.  The  railroad,  or  the  local  public  service  corpora- 
tion, offers  here  no  peculiar  economic  characteristics. 

Thus  the  Wisconsin  Commission  has  run  far  afield  from 
a  cost  of  producing  "going  value."  Analyzed  in  these 
terms,  the  scheme  which  received  the  approval  of  Com- 
missioner Lane  is  seen  to  have  passed  over  the  point  in 
controversy.  The  "supply  price"  of  business  relations 
cannot  be  measured  by  past  "deficits,"  which  are  depend- 
ent upon  earnings,  and  can  have  no  logical  place  in  the 
measurement  of  the  reasonableness  of  the  return.  The 
period  during  which  effort  is  expended  (and  funds  di- 
verted) toward  the  creation  of  these  relations  may  in  large 
measure  coincide  with  an  early  " starvation  period."  But 
by  no  means  necessarily.  And  it  is  also  true  that  the 
source  of  earnings  aptly  termed  "business  organization 
and  connection  "  l  is  built  up  by  all  firms  alike.  The  ven- 
ture which  has  surpassed  the  "representative  "  mark,  and 
the  venture  which  has  failed  to  reach  that  mark,  have 
1  Alfred  Marshall,  Principles  of  Economics,  page  625. 


INTANGIBLES  177 

both  met  these  costs.  "Going  value"  is  not  confined  to 
the  enterprise  which  can  point  to  "representative  "  manage- 
ment. But  how  shall  it  be  measured? 


No  case  better  illustrates  the  uncertainty  with  which  the 
"going  value"  problem  has  been  treated  than  the  decision 
of  the  New  Jersey  Commissioners  in  the  Public  Service 
Gas  Case.  They  first  accepted  the  testimony  of  an  "ex- 
pert" who,  hesitating  "to  name  an  exact  figure  for  an 
intangible  figure  of  this  kind,"  was  finally  prevailed  upon 
to  place  the  "going  value"  at  thirty  per  cent  of  the 
"structural  value."  The  actual  allowance  made,  however, 
was  $1,025,000,  the  "approximate  average"  of  $1,102,789 
(the  thirty  per  cent),  and  $950,000.1  This  $950,000  was 
"the  medium"  of  the  "upper  and  lower  estimates"  of 
another  "expert."  The  latter  was  understood  to  define 
"going  concern  value"  as  "what  a  property  would  fetch 
from  a  buyer  in  excess  of  the  cost  of  the  physical  property." 
His  calculation  assumed  that  "  such  a  concern  could  be 
financed  by  five  per  cent  bonds,  selling  at  90,  whose  interest 
would  be  two  thirds  of  the  anticipated  earnings."  The 
remaining  capitalization  would  be  represented  by  stock 
bearing  ten  per  cent.  The  excess  of  capitalization  over  the 
cost  of  the  physical  plant  gave  "going  concern  value"  of 
between  $900,000  and  $1,000,000.  So,  when  the  Commission 
took  the  "medium"  of  these  "higher  and  lower  estimates," 
$950,000,  and  secured  an  arithmetical  average  of  this 
amount  and  the  "thirty  per  cent"  guess,  $1,025,000  was 
fixed  as  a  "fair  value."  2 

1  In  re  Rates  Public  Service  Gas  Co.,  1  N.J.B.P.U.C.  433,  476,  478, 
479. 

2  The  New  Jersey  Court  of  Errors  and  Appeals,  in  Public  Service  Gas 
Co.  v.  Board  of  Public  Utility  Commissioners,  92  Atlantic  606,  upheld  this 
"quotient  method."    "Findings  of  this  character  by  juries  are  so  com- 
mon" (page  608). 


178  RAILROAD  VALUATION 

But  the  Commission  did  not  intend  to  imply  that  this 
figure  was  meant  to  cover  "bond  discount,"  which,  as  a 
mere  adjustment  of  the  rate  of  interest,  can  have  no  legiti- 
mate place  in  an  appraisal  of  "investment."  l  The  con- 
venient figures  were,  it  would  seem,  adopted  without 
critical  analysis  of  their  validity.  The  aim  of  the  Commis- 
sion was  simply  to  make  a  bulk  allowance  to  cover  a  series 
of  unrelated  elements,  which  were  called  to  its  attention  by 
the  company  "experts."  Not  only  were  items  included 
which  we  have  already  indicated  as  claiming  no  place  in 
"fair  value":  depreciation  unearned,  and  the  "dearth  of 
adequate  returns";  but  also  "  the  cost  of  soliciting  business, 
the  cost  of  advertising,  the  cost  of  inducing  customers  to 
take  the  service,  the  cost  of  exhibiting  appliances,  the  cost 
of  occasional  free  installation."  2  So,  though  an  "average" 
calculation  was  resorted  to  in  order  to  fix  upon  a  "going 
value,"  it  was  not  in  fact  assumed  that  bond  discount  was 
to  be  measured. 

The  case  was  appealed  to  the  New  Jersey  Supreme 
Court,  and  the  elements  which  the  Court  approved  as 
properly  allowed  in  "going  value"  were  substantially 
those  recognized  by  the  Commission.  Interest  during  con- 
struction and  "deficits"  below  the  "fair  return"  were  first 
cited;  "the  obsolescence  of  the  plant  apart  from  that  cal- 
culable depreciation  which  may  be  charged  to  currrent 
expenses  instead  of  being  capitalized;  the  expense  that 

1  See  Whitten,  Valuation  of  Public  Service  Corporations,  chapter  xm, 
page  268  and  following,  especially  pages  281-82,  indicating  the  contra- 
dictory and  illogical  treatment  of  the  subject  by  the  Wisconsin  Com- 
mission. 

2  In  re  Rates  Public  Service  Gas  Co.,  1  N.  J.B.P.U.C.  433,  469.  These 
elements  of  "going  value"  do  not  represent  the  fruits  of  original  reason- 
ing on  the  part  of  the  Commission.   In  fact,  they  are  as  complete  an  ac- 
ceptance of  the  pretensions  of  the  public  utility  operators  as  is  conceivable. 
See  State  Journal  Printing  Co.  v.  Madison  G.  &  E.  Co.,  4  W.R.C.R.  501, 
570,  where  the  testimony  of  the  same  group  of  experts,  making  the  same 
assertions,  failed  to  receive  sympathetic  reception.   However,  the  New 
Jersey  Commission  was  apparently  new  to  the  ways  of  expert  witnesses. 


INTANGIBLES  179 

must  attend,  and  the  additional  value  that  arises  from  the 
uniting  of  separate  concerns,  and  the  organization  of  a 
great  industry  with  the  view  to  economical  production."  l 
Then,  though  like  the  Commission,  protesting  that  "  good- 
will" was  not  to  be  considered,  Justice  Swayze  added  the 
other  elements  included:  "The  cost  of  securing  and  retain- 
ing customers,  of  encouraging  the  greater  use  of  gas  for  fuel 
and  for  light  by  the  introduction  of  new  and  improved 
appliances."  2 

The  Court  insisted  that  the  "practical  business  ques- 
tions," presented  by  this  series  of  considerations,  were  dif- 
ferent from  the  legal  questions.  The  business  questions 
concerned  the  mode  of  handling  upon  the  books;  but  the 
legal  question  was  "whether  these  items  constitute  a  going 
value  upon  which  the  company  is  entitled  to  a  return."  To 
this  question,  the  Court  gave  an  affirmative  answer.  For 
"if  by  value  we  mean  what  the  economists  call  exchange 
value,  then  a  buyer  would  undoubtedly  give  more  for  a  plant 
already  doing  a  profitable  business  than  for  a  plant  of  equal 
cost,  capacity,  and  future  possibilities  but  without  the  es- 
tablished business." 3  This  argument  is  inconclusive  when 
the  mode  of  measurement  and  the  purpose  are  considered. 
Even  where  an  exchange  value  is  sought,  to  use  Justice 
Swayze's  premise,  the  amounts  spent  for  advertising,  etc., 
would  not  be  important.  Their  results,  as  reflected  in  the 
total  earnings,  would  be  the  vital  concern.  But  the 
"  value  "  to  be  considered  in  a  rate  case  is  not  an  exchange 
value  (as  the  opinion  later  indicates?).  Seemingly  the 
Court  unconsciously  worked  into  the  very  circle  against 
which  specific  warning  was  given.  One  reason,  apparently 

1  Public  Service  Gas  Co.  0.  Board  of  Public  Utility  Commissioners, 
87  Atlantic  651,  657. 

2  Ibid.     See  Justice  Swayze's  discussion  in  the  Quarterly  Journal  of 
Economics,  volume  26,  pages  422-23,  where  the  same  general  reasoning 
is  found. 

8  Public  Service  Gas  Co.  c.  Board  of  Public  Utility  Commissioners. 
87  Atlantic  651,  658. 


180  RAILROAD   VALUATION 

the  significant  reason,  why  the  established  concern  (if  its 
operations  have  proved  successful)  will  sell  for  a  higher 
price  is  because  the  degree  of  risk  is  readily  ascertainable. 
The  earnings  (actual  and  prospective)  are  in  larger  degree 
capable  of  estimate  and  are  capitalized  at  a  lower  rate. 
The  new  concern  must  face  greater  and  unknown  risks. 

The  series  of  items  included  in  the  scope  of  the  Court's 
definition  of  "going  value"  are  so  varied,  bearing  no 
apparent  relation  to  each  other,  that  the  same  reasoning 
cannot  be  made  to  apply  to  each  set  of  items.  Obsolescence 
may  be  "capitalized"  —  upon  what  grounds?  The  argu- 
ment for  such  allowance  is  not  to  be  found  in  the  Court's 
opinion;  yet  the  idea  is  not  a  new  one.  Railroad  men  have 
contended  that  in  the  case  of  the  abandonment  of  perma- 
nent structures,  made  necessary  by  "progress  in  the  arts," 
the  cost  of  the  discarded  property  should  be  considered  as 
the  "cost  of  progress"  and  added  to  any  appraisal  of 
physical  assets.1  The  instances  have  been  cited  of  the 
Grand  Central  Station  in  New  York  which  "  involved  the 
wiping-out  of  an  enormous  expenditure  by  the  New  York 
Central  lines,"  of  "abandonments  along  the  whole  line  of 
the  Pennsylvania  Railroad  Company,"  and  of  the  Union 
Pacific  which  "  General  Dodge  would  have  built  .  .  .  just 
where  it  is  to-day  if  he  had  had  the  money  to  do  it."  2 
Or,  "  in  the  development  of  a  railroad  it  not  infrequently 
happens  that  a  portion  of  the  original  line  is  abandoned. 

1  This  idea  seems  to  have  been  developed  by  W.  H.  Williams,  of  the 
Delaware  &  Hudson.  At  least  it  is  ascribed  to  him  in  discussions  by  rail- 
road men.  See,  for  example,  testimony  of  Mr.  Frank  Trumbull,  chairman 
of  the  Board  of  the  Chesapeake  &  Ohio,  Senate  Report  on  Valuation,  page 
36. 

*  Testimony  of  Mr.  Trumbull.  Mr.  Trumbull  was  urging  inclusion 
in  the  Federal  Valuation  Bill  of  the  clause  permitting  the  Commission 
(when  the  fact  was  deemed  "pertinent")  to  "ascertain  and  report .  .  . 
the  cost  of  property  not  worn  out,  but  abandoned  to  aid  .in  the  develop- 
ment of  better  or  more  economical  service  to  the  public. "  Senate  Report 
on  Valuation,  page  32.  He  would  leave  the  "consideration"  of  property 
abandoned  "on  account  of  the  necessity  of  progress"  with  the  Commis- 
sion (page  37). 


INTANGIBLES  181 

The  interests  of  the  public  justify  the  reconstruction  of  a 
certain  portion  of  the  old  line  reducing  grades  and  per- 
haps serving  new  localities,  and  in  the  end  the  old  line  is 
abandoned."  l 

The  fallacy  in  the  contention  that  plant,  no  longer  in  the 
productive  process,  should  be  included  in  an  appraisal  rests 
in  the  failure  to  recognize  that  the  abandonments  have 
been  made  in  the  interest  of  the  railroads,  not  in  the  in- 
terest of  the  public.  Spending  "millions  and  millions  of 
dollars"  in  building  the  new  Union  Pacific  was  justified 
that  the  road  "might  haul  freight  cheaper,  which  would 
augment  the  net  earnings." 2  If  the  public  gained  by  way 
of  improved  service,  that  gain  was  quite  secondary  to  the 
possibility  of  financial  gain  to  the  company,  which  from 
the  business  standpoint  (and  the  economic)  justified  the 
improvements.  The  reason  why  the  old  Grand  Central 
Station,  entirely  adequate  in  its  day,  was  torn  down  and 
replaced  by  the  new,  was  because  the  concentration  of 
population  and  business  in  New  York  so  increased  the 
density  of  traffic  that  the  volume  of  earnings  accruing  was 
thought  to  justify  the  change.  Otherwise  the  scrapping  of 
the  old  and  the  building  of  the  new  meant  conscious  eco- 
nomic waste.  And  the  changes  of  line,  the  elimination  of 
curvature,  the  lowering  of  grades,  can  only  be  justified  by 
parallel  reasoning.  The  immediate  reason  why  General 
Dodge  did  not  locate  the  Union  Pacific  in  its  present  site 

1  G.  F.  Swain,  the  New  Haven  Validation  Report,  page  57.   See  E.  P. 
Ripley,  "The  Railroads  and  the  Public,"  Atlantic  Monthly,  volume  107, 
page  19.  The  following  is  from  an  earlier  opinion  of  the  Interstate  Com- 
merce Commission  (In  the  Matter  of  Advances,  9  I.C.C.  382,  402),  the 
opinion  being  by  Commissioner  Prouty:  "In  the  development  of  that 
industry  they  [the  railroads]  have  been  reconstructed  and  improved,  the 
first  outlay  has  perhaps  been  rendered  practically  worthless.  .  .  .  Those 
who  originally  invested  their  money  in  this  enterprise  and  have  kept  pace 
with  the  public  necessities  ought  not  to  be  required  to  bear  the  entire 
burden  of  this  shrinkage." 

2  A  frank   acknowledgment  by  Mr.  Trumbull.    Senate   Report  on 
Valuation,  page  37. 


182  RAILROAD  VALUATION 

may  have  been  lack  of  funds.  But  the  funds  were  not 
forthcoming  because  there  was  general  doubt  whether 
even  the  low-standard  line  could  be  made  to  pay.  The 
traffic  possibilities,  as  seen,  and,  for  a  long  time,  as  realized, 
of  the  tributary  territory  did  not  warrant  greater  expendi- 
ture in  construction.  With  increase  in  traffic  density,  and 
necessity  for  longer  trains  to  secure  economical  handling, 
elimination  of  curvature  and  lowering  of  the  ruling  grade 
were  essential.  The  old  line  had  then,  in  economic  analy- 
sis, come  into  exactly  the  same  situation  as  any  other 
plant,  or  machinery,  abandoned  as  unworkable. 

That  the  grade  itself  does  not  disappear  cannot  hide 
the  essential  fact.  The  labor  (and  therefore  the  "invest- 
ment") spent  in  building  the  grade,  the  bridge,  the  tunnel, 
has  been  used  up.  There  is  no  longer  possibility  of  future 
contribution  to  the  productive  process.  The  grading  of  a 
railroad  is  simply  a  specialized  case  of  "  capital  sunk  in  the 
soil."  When  it  ceases  to  be  workable,  the  investment  has 
been  used  up.  One  of  two  things  has  happened:  either  the 
earnings  of  the  plant  as  a  whole  have  included  a  return 
of  the  investment  originally  made  hi  the  plant  now  aban- 
doned, or  a  risk  of  the  business  has  materialized.  No  other 
conclusion  is,  it  is  submitted,  tenable.  "A  more  complete 
depreciation  than  that  which  is  represented  by  a  part  of  the 
original  plant  that  through  destruction  or  obsolescence  has 
actually  perished  as  useful  property,  it  would  be  difficult 
to  imagine."  1 

The  difficulty  brought  up  by  the  inclusion  of  "the  ex- 
pense that  must  attend,  and  the  additional  value  that 
arises  from  the  uniting  of  separate  concerns,"  raises  again 
a  point  already  indicated.  Seemingly,  in  spite  of  the  men- 
tion of  "expense,"  the  Court  did  not  have  in  mind  the  cost 
of  bringing  about  the  consolidation,  including  in  "cost" 
such  reward  as  might  be  necessary  to  stimulate  the  incep- 
1  Kansas  City  Southern  Ry.  Co.  v.  U.S.,  231  U.S.  423,  448. 


INTANGIBLES  183 

tion  and  completion  of  the  consolidation.  The  evidence  for 
this  conclusion  is  in  another  passage  of  the  opinion: 

"We  think  the  counsel  for  the  company  right  in  their  con- 
tention that  the  value  of  an  assembled  and  united  plant 
may  be  greater  than  the  total  value  of  the  separate  parts. 
The  examples  given  of  the  increased  value  of  the  New  York 
Central  Railroad  over  the  value  of  its  consitutent  parts, 
Cleveland,  etc.  Ry.  Co.  v.  Backus,  .  .  .  suffice  to  illustrate 
the  difference  between  the  value  of  a  whole  plant,  and  the 
value  of  its  parts.  The  advantage  of  large  scale  production 
over  small  scale  at  several  plants  is  too  well  known  to  require 
more  than  mention,  and  the  getting  together  of  property 
sufficient  for  the  purpose  no  doubt  may  create  a  real  value, 
which  may  be  allowed  for  in  going  value."  l 

But  since  the  advantage  of  large-scale  production  is  only 
reflected  through  earnings,  and  therefore  through  market 
value  ("exchange  value"),  the  argument  here  reproduced 
is  beside  the  point.  The  "  expense,"  the  "  cost,"  but  not  the 
"additional  value"  can  demand  consideration  in  regula- 
tion proceedings. 

Final  attention  turns  to  the  proposal  which  would  set  up 
selling  costs  as  "investment."  Here,  though  the  conclusion 
of  the  Commission  and  of  the  New  Jersey  Court  cannot  be 
accepted,  a  possible  analysis  of  the  problem  is  suggested  by 
the  argument,  which  must  itself  be  rejected.  The  Court 
understood  the  Commission  to  have  intended  that  the  bulk 
allowance  for  "going  value"  should  cover  all  costs  of 
soliciting  business,  and  attracting  new  customers.  "No 
doubt  fair-minded  men  may  differ,"  said  Justice  Swayze, 
"  but  as  the  Commission  seems  to  have  allowed  the  actual 
expenses  proved,  and  permitted  the  whole  to  be  capitalized, 
even  when  paid  out  as  current  expenses  from  current  rates 
...  no  injustice  was  done  in  this  respect"  (i.e.,  to  the 
company).2 

1  Public  Service  Gas  Co.  c.  Board  of  Public  Utility  Commissioners,  87 
Atlantic  651,  658. 
8  Ibid. 


184  RAILROAD  VALUATION 

Indeed,  in  order  to  avoid  "injustice,"  the  company  was, 
in  substance,  permitted  to  capitalize  against  the  public 
certain  parts  of  the  cost  of  its  products  furnished  in  the 
past.  The  difficulty  which  led  to  the  confusion  arose  be- 
cause the  customer  secured  by  the  initial  expenditure,  in  the 
general  run  of  cases,  continued  to  be  a  purchaser  of  service 
(in  the  New  Jersey  Case,  gas,)  through  a  long  period  of 
years.  The  expense  of  attaching  the  customer  to  the  busi- 
ness was  incurred  once  for  all  at  the  beginning.  Business 
practice  had  not  set  up  any  part  of  this  first  cost  as  a  "  de- 
ferred asset,"  presumably  aiming  in  the  interest  of  conserv- 
atism to  overstate  rather  than  run  the  risk  of  understat- 
ing current  operating  expenses.  But,  from  the  point  of 
view  of  economic  analysis,  there  is  no  reason  why  such  a 
"deferred  asset"  account  might  not  have  been  set  up,  to 
measure  the  amount  of  any  cost  properly  spread  over  the 
future.  Such  an  account  would  not,  however,  measure  a 
permanent  level  of  "investment."  It  would  be  necessary 
each  year  to  charge  off  a  pro  rata  share.  The  situation  is 
parallel  with  that  presented  by  the  charge  against  current 
earnings  to  compensate  the  depreciation  of  fixed  assets. 

The  New  Jersey  Commission  had  not  bothered  with  such 
refinements;  nor  did  the  Court.  All  advertising  and  so- 
liciting expenses  (in  the  case  of  the  railroad  all  "traffic 
expenses")  were,  according  to  their  doctrine,  simply  in- 
vestment in  that  "property"  which  is  in  the  shape  of  "ex- 
clusive patronage."  The  argument  used  to  justify  this 
conclusion  can  best  be  given  in  the  Commission's  own 
language: 

"If  in  the  past,  this  company  out  of  the  rates  exacted  from 
consumers  had  met  its  operating  expenses  and  depreciation, 
and  in  addition  thereto  had  obtained  enough  to  pay  returns 
to  investors  and  to  build  an  actual  structure  used  in  the 
business,  would  this  structure  be  the  lawful  property  of 
the  company?"  l 

1  In  re  Rates  Public  Service  Gas  Co.,  1  N.  J.B.P.U.C.  433,  470. 


INTANGIBLES  185 

The  affirmative  answer  given  this  query  is  entirely  in  line 
with  our  own  previous  analysis.  Now,  said  the  Commission, 
suppose  that  the  company,  instead  of  buying  plant,  spends 
a  part  of  its  income  in  advertising  and  soliciting  campaigns. 
Does  not  the  company  thereby  "acquire  an  intangible 
property  in  the  shape  of  exclusive  patronage"?  It  was  on 
this  ground  that  the  sums  spent  for  soliciting  were  held  to 
represent  investment,  "for  the  business  thus  acquired  must 
be  regarded  as  a  legitimate  part  of  the  property  of  the  com- 
pany." l  But  the  real  difficulty  was  glossed  over  by  the 
Commission.  The  attempt  to  compare  the  expense  of  dis- 
tribution with  amounts  diverted  to  the  purchase  of  new 
plant  (the  calling  of  both,  "  investment ")  failed  to  recog- 
nize that  it  must  be  entirely  a  matter  of  conjecture  how 
much  gross  income  would  have  been  in  the  absence  of  such 
expenditures.  It  cannot  be  assumed  that  the  amount 
charged  to  soliciting,  etc.,  would  have  been  available  for 
further  investment  in  plant  had  the  expense  of  securing 
business  been  omitted.  The  volume  of  gross  earnings 
annually  accruing  has  been  dependent  in  part  on  the 
amount  spent  for  soliciting,  etc.,  in  that  year. 

Some  part  of  the  expense  of  selling  the  product,  whether 
it  be  coal,  or  gas,  or  ton-miles,  consists  of  the  cost  of  making 
the  particular  sale.  How  much,  it  would  be  difficult,  if  not 
impossible  to  say.  Some  of  the  effort  fails  entirely  of  result, 
like  the  effort  expended  in  making  a  machine  which  proves 
useless.2  There  may  also  be  some  very  real  investment. 
But  in  the  absence  of  records,  or  attempt  by  the  companies 
to  carry  such  accounts,  the  task  of  "appraising"  the 
"intangible"  appears  a  baffling  one.  Even  having  the 
amount  of  an  original  entry  (which  might  have  been  made), 


1  In  re  Rates  Public  Service  Gas  Co.,  1  N.J.B.P.U.C.  433,  475.  Yet 
(page  480)  the  Commission  insisted  that  no  consideration  could  be 
granted  "good-will"! 

8  Apparently,  Justice  Swayze  included  in  "going  value"  the  cost  of 
machines  made  for  experiment,  etc.  (87  Atlantic  651,  657). 


186  RAILROAD   VALUATION 

how  much  of  this  first  "cost"  can,  at  a  given  date,  be  said 
to  remain  "undepreciated"?  In  short,  how  long  will  the 
customer  continue  to  buy  service,  and  to  what  extent  will 
the  volume  of  his  consumption  expand,  etc.?  The  measure- 
ment of  the  accrued  depreciation  in  the  physical  plant 
appears  as  child's  play  compared  with  this. 

Consider  an  attempt  to  make  use  of  the  analysis  here 
outlined  hi  "railroad  valuation,"  when  the  competition  of 
carriers  for  business  is  so  keen  over  wide  areas.  The  expense 
of  bringing  settlers  to  the  tributary  country,  of  securing 
an  industry  to  locate  along  the  line  of  the  railroad,  etc., 
might  be  such  an  expense  as  would  be  chargeable  against 
income  subsequently  accruing.  But,  in  the  face  of  active 
competition,  it  would  seem  that  the  largest  part  of  "  traffic 
expenses  "  are  not  to  be  spread  over  a  period  of  years.  What 
would  be  the  effect  of  discontinuing  the  solicitation  of 
traffic  cannot  even  be  conjectured.  Present  solicitation, 
present  effort  to  get  business,  is  probably  hi  largest  meas- 
ure chargeable  against  the  returns  from  that  business. 
That  some  amounts  might  be  recognized  as  "costs"  of 
securing  the  permanent  relations  may,  nevertheless,  be 
granted.  But  how  fix  upon  the  "undepreciated"  volume 
of  this  figure  of  "value,"  within  limits  of  accuracy  useful 
for  a  standard  of  "reasonableness"? 

The  "cost  of  building  up  the  organization"  also  de- 
mands an  attempt  to  measure  effort  and  sacrifice  made 
once  for  all,  usually  in  the  beginning.1  But  its  determina- 

1  See  Argument  of  Burton  Hanson,  for  the  C.M.  &  St.P.,  Evidence, 
1910  Advances,  page  3713.  Parallel  language  was  used  by  the  attor- 
neys for  the  Companies  in  the  Minnesota  Rate  Cases:  "Value  which  is 
reflected  by  added  earning  power  derived  from  the  .  .  .  possession  of  an 
efficient  organization,  a  past  record  of  prompt  and  efficient  operation, 
giving  the  property  and  its  organization  a  standing  in  the  commercial 
communities  it  serves."  Brief,  page  159. 

Henry  C.  Adams'  appraisal  of  the  "intangible"  elements  of  value  in 
Michigan,  determined  through  capitalizing  earnings,  included  a  "value" 
on  account  of  the  "organization  and  vitality"  of  the  railroad.  Bulletin 
21,  Bureau  of  the  Census,  Commercial  Valuation  of  Railway  Operating 


INTANGIBLES  187 

tion  is  equally  elusive.  Neither  for  "good- will"  ("con- 
nected value"),  nor  for  this  "cost"  of  creating  an  organiza- 
tion does  there  seem  a  possibility  of  indicating  any  figures 
which  should  distinguish  between  expenses  chargeable  in 
the  past  against  income  from  current  operations,  and  the 
income  from  future  operations.  Such  a  differentiation  must 
have  been  difficult  in  the  past.  It  does  not  seem  at  all 
feasible  now. 

The  present  economic  structure  functions  more  effec- 
tively because  effort  has  been  expended,  not  in  the  making 
of  machines  ("capital  goods")  alone,  but  in  the  creation 
of  "good- will,"  and  of  well  coordinated  business  organiza- 
tions. The  costs  of  these  efforts  are  the  "expenses  of  pro- 
duction "  of  the  going  concern.  "  Going  value  "  would  seem, 
therefore,  more  properly  applied  to  these  two  costs,  rather 
than  to  the  cost  of  business  relations  alone.  The  business 
man  generally  conceives  of  his  return  on  such  amounts,  if 
indeed  he  gives  them  a  thought,  simply  in  terms  of  a  higher 
return  on  the  cost  of  his  tangible  assets,  his  investment  in 
plant.  It  is  a  part  of  the  return  for  skillful  management, 
a  part  of  the  differential  return  appearing  in  "  business 
profits." 

Certainly  data  are  not  available  for  a  measurement  that 
would  carry  with  it  any  assurance  of  reliability.  The  con- 
jectural nature  of  the  "valuation"  of  tangible  assets  has 
already  been  indicated.  For  an  appraisal  of  "going  value," 
here  comprehending  both  "business  organization  and  con- 
nection," this  uncertainty  is  multiplied  many  fold.  No 
usable  solution  appears  possible. 

Property,  page  78.  See  In  re  Arkansas  Rates,  187  Fed.  290,  319;  and 
S.  O.  Dunn,  American  Transportation  Question,  pages  95  and  96. 


CHAPTER  VH 

THE  RETURN   TO   THE  RAILROAD 

The  rate  of  return  as  considered  by  the  Commission,  188.  —  By  the 
courts,  190.  — The  legal  rate  of  interest,  191.  — Willcox  v.  Consoli- 
dated Gas  Co.,  191.  —  The  "risk  element,"  192.  —  The  incidence  of  a 
shifting  price  level,  194.  —  Railroad  credit,  194.  —  "Unproductive" 
improvements,  195.  —  The  creation  of  economic  rent,  200.  —  The 
differential  element  in  profits,  202.  —  The  "unearned  increment"  once 
more,  203. 

THE  nature  of  the  problems  presented  to  the  Interstate 
Commerce  Commission,  in  the  cases  where  "valuation" 
has  been  discussed  as  a  measure  of  reasonableness,  accounts 
for  the  uncertain  and  inconclusive  treatment  of  the  rate  of 
return  in  those  decisions.  Where  reductions  have  been  in 
contemplation,  a  circumstance  which,  it  would  seem, 
would  force  a  discussion  of  the  "fair"  rate  of  return, 
"valuation"  has  proved  secondary  to  the  considerations 
governing  the  reasonableness  of  the  individual  charge,  and 
the  removal  of  discrimination.  In  the  Advance  Cases,  on 
the  other  hand,  no  affirmative  stand  has  been  required.  It 
has  been  sufficient  for  the  Commission  to  hold  that  the 
revenue  received  by  the  carriers  under  the  old  schedules 
has  been  inadequate.1  In  this  respect,  the  position  of  the 
Commission  has  been  comparable  to  that  of  the  judiciary 
when  attempting  to  determine  whether  rates  have  been 
"so  unreasonably  low"  as  to  be  confiscatory. 

The  task  of  determining  a  reasonable  rate  of  return  de- 
mands recognition,  at  a  given  moment,  of  forces  the  opera- 
tion of  which  can  be  distinguished  only  in  the  long  run. 
Though  it  be  true  that  the  road  once  built  will  be  continued 
in  operation  while  it  nets  but  little,  perhaps  nothing,  on 

1  See  discussion  above,  page  2  and  following,  and  the  cases  there  cited. 


THE  RETURN  TO  THE  RAILROAD  189 

the  "fixed"  investment,  the  prospect  of  the  return  which 
would  be  received  in  enterprises  requiring  equal  assump- 
tion of  risk,  equal  foresight  in  planning,  equal  efficiency  in 
management,  must  be  held  out  to  the  investor  at  the  be- 
ginning of  construction.  This  does  not  mean  that  the  public 
should  in  effect  say  to  every  promoter  of  a  railroad:  build 
the  line,  and  it  will  be  permitted  to  make  such  charges  as 
net  the  going  rate  of  return  on  the  investment.  Though 
there  be  conspicuous  successes  in  the  railroad  business, 
there  may  be  here,  as  in  other  lines  of  economic  activity, 
dismal  failures.  The  risk  of  failure  the  public  has  not  borne; 
instead  it  has  left  the  field  open  to  private  enterprise.  If 
the  risk  shall  materialize,  if  the  venture  prove  ill-founded,  a 
reasonable  rate  of  return  will  be  less  than  when  the  venture 
has  been  wisely  conceived.1  For  the  rate  of  return  must 
consider  not  alone  payment  for  present  risk,  but  a  pay- 
ment of  past  risks  assumed;  and,  above  all,  for  skill  and 
judgment  exercised.  At  the  present  moment,  therefore, 
though  risk  must  be  compensated  in  the  rate  of  return,  the 
payment  is,  in  largest  degree,  a  payment  for  risk  assumed 
in  the  past.  Not  the  insurance  element  in  profits,  but  the 
payment  for  business  sagacity  (or  the  penalty  for  its  lack) 
is  now  the  more  significant  factor. 

1  In  the  1910  Advance  Cases  the  Commission  based  its  discussion 
upon  calculations  covering  the  situation  of  the  Baltimore  &  Ohio,  the 
New  York  Central,  and  the  Pennsylvania,  which  were  chosen  as  "  typical " 
lines  (Eastern  Case,  20  I.C.C.  243,  274);  and  of  the  C.B.  &  Q.  and  Santa 
Fe  in  the  Western  Case.  In  the  Eastern  Case  the  roads  considered  were 
those  which  had  been  discussed  in  the  Advance  Case  of  1903.  (9  I.C.C. 
382,  425.)  The  Railway  Age  Gazette  in  its  editorial  columns  attacked  the 
choice  of  roads  taken  as  "typical,"  volume  50,  page  464.  Indeed  the  at- 
torney for  the  Commission  had  called  the  C.B.  &  Q., "  one  of  the  best 
operated  and  most  prosperous."  (Evidence,  1910  Advances,  page  3522.) 
The  idea  ;of  an  "average  road"  was  advanced  at  various  points  in 
the  hearings,  however,  usually  by  railroad  men.  -  (Evidence  page  5038, 
W.  C.  Brown;  page  5038,  James  McCrea;  page  2625,  Jos.  Ramsey,  Jr.; 
and  page  4130,  Brief  for  the  Illinois  Manufacturers  Association.) 

In  the  Five  Per  Cent  Case,  the  New  York  Central,  the  Baltimore  & 
Ohio,  and  the  Pennsylvania  were  urged  upon  the  Commission  as  "typi- 
cal," 31  I.C.C.  350,  420. 


190  RAILROAD   VALUATION 

The  American  railroad  net  was  created  without  govern- 
ment guarantee.  It  was  almost  solely  the  product  of  pri- 
vate initiative,  the  roads  built  as  competitive  enterprises. 
The  pioneer  railroad  (and  few  even  of  the  roads  most 
recently  built  have  not,  to  some  extent,  been  pioneers), 
like  the  pioneer  settler  who  followed  in  its  path,  exercised 
no  exclusive  privilege.  On  the  contrary,  in  order  to  tempt 
men  of  ability  to  take  up  these  highly  speculative  ventures 
(and  imagination  and  courage  were  elements  in  this 
ability),  it  was  necessary  to  offer  land  grants,  and  even 
opportunities  of  making  gains  which,  in  this  day  of  more 
settled  industrial  conditions,  are  sometimes  looked  upon  as 
piratical.  There  was  always  the  risk  that  the  venture 
would  fail,  that  population  could  not  be  attracted  to  the 
new  country.  From  the  nature  of  the  case  it  was  recognized 
that  the  road  could  not  be  made  "to  pay"  at  once.  But  the 
income  which  it  was  expected  would  accrue  as  the  country 
became  settled,  as  cities  grew,  etc.,  necessarily  entered  into 
the  calculations  of  the  investor  who  participated  in  the 
building  of  the  road.1 

So  far  as  there  has  been  discussion  of  the  rate  of  return  by 
the  judiciary,  hi  the  fixing  of  the  minimum  level,  the  risk 
aspect  has,  indeed,  been  emphasized.  This  has  been  due  hi 
largest  degree  to  the  character  of  the  cases  presented,  and 
to  the  peculiar  twist  given  the  reasoning  through  building 

1  Alfred  Marshall,  Principles  of  Economics,  pages  429-30:  "The  early 
settler  .  .  .  undergoes  many  hardships,  if  not  personal  dangers;  and  per- 
haps he  runs  some  risk  that  the  land  may  turn  out  badly,  and  that  he  may 
have  to  abandon  his  improvements.  On  the  other  hand  his  venture  may 
turn  out  well;  the  flow  of  population  may  trend  his  way,  and  the  value 
of  his  land  may  soon  give  as  large  a  surplus  over  the  normal  remuneration 
of  his  outlay  on  it  as  the  fishermen's  haul  does  when  they  come  home  with 
their  boat  full.  But  in  this  there  is  no  surplus  above  the  rewards  needed 
for  his  venture.  He  has  engaged  in  a  risky  business  which  was  open  to  all, 
and  his  energy  and  good  fortune  have  given  him  an  exceptionally  high 
reward:  any  one  else  might  have  taken  the  same  chance  as  he  did.  Thus 
the  income  which  he  expects  the  land  to  yield  in  the  future  enters  into 
the  calculations  of  the  settler,  and  adds  to  the  motives  which  determine 
his  action  when  in  doubt  as  to  how  far  to  carry  his  enterprise." 


THE   RETURN   TO  THE   RAILROAD  191 

on  judicial  dicta  in  opinions  subsequent  to  the  opinion  of 
the  Supreme  Court  in  the  New  York  Gas  Case.  The  lower 
court,  fixing  upon  the  rate  of  six  per  cent,  the  legal  rate 
in  New  York,  had  made  careful  reservation  that  this  was 
done,  not  because  six  per  cent  happened  "to  be  the  inter- 
est rate  by  law,"  but  because  it  was  "the  return  ordina- 
rily sought  and  obtained  on  investments  of  that  degree  of 
safety."  *  When  the  case  came  to  the  Supreme  Court, 
Justice  Peckham  hi  substance  accepted  the  doctrine  of  the 
lower  court:  "There  is  no  particular  rate  of  compensation 
which  must  in  all  cases  and  in  all  parts  of  the  country  be 
regarded  as  sufficient  for  capital  invested  in  business 
enterprises.  Such  compensation  must  depend  greatly  upon 
circumstances  and  locality  .  .  .  the  amount  of  risk  »  .  . 
other  matters  might  also  be  properly  taken  into  account." 
The  opinion,  however,  did  not  point  out  what  might  con- 
stitute such  "other  matters."  Investment  in  the  gas  busi- 
ness in  New  York  representing  a  minimum  of  risk,  it  was 
held  that  the  company  was  "entitled  to  six  per  cent  upon 
the  total  value  of  the  property."  2 

This  is  the  most  explicit  definition  of  the  amount  of  a 
"  non-confiscatory "  return  given  by  the  Supreme  Court. 
But,  if  six  per  cent  constituted  the  lowest  limit  in  the  case 
of  "the  most  favorably  situated  gas  business  in  America," 
the  lower  courts  possessed  a  bench-mark  from  which  to 
measure.  Accordingly  seven,  seven  and  a  hah*,  and  even 

1  157  Fed.  849,  870.  The  Master  had  used  six  per  cent,  because  it  was 
the  legal  rate.  Report  of  A.  H.  Masten,  page  255,  Willcox  v.  Consolidated 
Gas  Co.,  212  U.S.  19. 

The  legal  rate  was  established  as  a  minimum  in:  L.  &  N.  R.R.  Co.  v. 
Brown,  123  Fed.  946,  951;  Pennsylvania  Railroad  v.  Philadelphia  County, 
220  Pa.  100,  115;  Central  of  Georgia  Ry.  Co.  v.  Railroad  Commission  of 
Alabama,  161  Fed.  925,  996;  Western  Railway  of  Alabama  c.  Railroad 
Commission  of  Alabama,  197  Fed.  954. 

It  was  attacked  as  too  low  (to  be  reasonable)  in  the  Brief  of  Messrs. 
Dunlap,  Norton  and  Lathrop  for  the  Santa  Fe.  Evidence,  1910  Advances, 
page  3579. 

8  Willcox  v.  Consolidated  Gas  Co.,  212  U.S.  19,  48-50. 


192  RAILROAD  VALUATION 

eight  per  cent l  have  been  established  as  the  line  between  a 
"confiscatory"  return  to  a  railroad,  and  one  "not  so  un- 
reasonably low."  And  the  factors  which  make  for  greater 
risk  in  the  railroad  business  than  in  that  of  furnishing  gas 
to  New  York  City  have,  on  the  whole,  been  treated  with 
insight.  The  possibility  of  invasion  of  territory  by  com- 
petitors, and  the  position  which  the  railroad  occupies  in 
relation  to  general  business  and  crop  conditions,  especially 
in  an  agricultural  community,  were  emphasized  in  the 
Arkansas  Case.2  Judge  Sanborn,  in  the  Minnesota  Case, 
also  indicated  the  dependence  of  the  railroad  prosperity 
upon  crop  conditions.3  One  of  the  Alabama  Masters  went 
so  far  as  to  declare  that  railroad  dividends  are  "  subject  to 
all  the  disasters  of  trade  and  to  none  of  its  extraordinary 
profits,"  4  happily,  an  obvious  exaggeration. 

In  the  Minnesota  Rate  Cases,5  much  was  made  of  the 
obligation  of  the  railroad  to  operate  even  in  the  face  of 

1  St.  L.  &  S.F.  Ry.  Co.  v.  Hadley  (Missouri  Case),  168  Fed.  317,  354 
(6  per  cent);  In  re  Arkansas  Rates,  187  Fed.  290,  347  (7f  per  cent);  L. 
&  N.  R.R.  Co.  v.  Railroad  Commission  of  Alabama,  197  Fed.  954,  958 
(8  per  cent);  Shepard  v.  N.P.  Ry.  Co.  (Minnesota  Case),  184  Fed.  765, 
815  (7  per  cent). 

2  In  re  Arkansas  Rates,  187  Fed.  290,  346-47:  See  testimony  of  J.  J. 
Hill,  Minnesota  Rate  Cases,  Record  (G.N.),  pages  1342-43,  and  1320-23. 

8  Shepard  v.  N.P.  Ry.  Co.,  184  Fed.  765,  815. 

4  "Railroad  business  is  confessedly  more  than  an  ordinarily  risky  one. 
The  roads  seldom  have  escaped  receiverships  and  bankruptcy  proceed- 
ings. The  business  is  subject  to  the  seasons,  to  wars,  panics,  pestilences, 
quarantines,  and  the  general  prosperity  of  the  country."  Report  of  W.  A. 
Gunter,  Special  Master,  South  &  North  Alabama  Case,  page  84.  To  the 
same  effect,  see  Western  Railway  of  Alabama  v.  Railroad  Commission  of 
Alabama,  197  Fed.  954,  959. 

6  Judge  Sanborn's  discussion  at  pages  815-16  of  his  opinion,  184  Fed. 
765,  simply  paraphrases  testimony  of  J.  J.  Hill,  Record  (G.N.),  pages 
1319  and  1341-42.  The  rate  which  he  approved  (seven  per  cent)  had 
been  suggested  by  C.  F.  Staples,  a  member  of  the  Minnesota  Railroad 
&  Warehouse  Commission,  as  a  minimum  for  the  "best  and  most  favor- 
ably situated  railroad."  The  railroads  on  appeal  to  the  Supreme  Court 
by  the  State  urged  that  a  rate  of  return  to  be  "reasonably  adequate  must 
be  higher  than  seven  per  cent."  Brief  for  the  Companies,  page  828  and 
following,  Minnesota  Rate  Cases,  230  U.S.  352. 


THE  RETURN  TO  THE  RAILROAD  193 

failure  to  make  a  "profit"  —  a  phrase  not  defined.  In- 
vestment in  a  factory,  for  example,  was  "substantially  free 
from  regulation  by  the  Government  and  exempt  from  any 
obligation  to  the  public,  except  that  of  paying  taxes.  If 
the  business  in  which  such  an  investment  is  made  is  un- 
profitable, its  owners  may  promptly  discontinue  its  op- 
eration until  more  prosperous  days  come  and  then  return 
to  their  undertaking."  Not  so  the  poor  railroad:  "Its 
owners  owe  the  duty  to  the  governments  and  to  the  public 
to  operate  then*  railroad  continually  in  days  when  its 
operation  is  unprofitable  as  well  as  when  it  is  remunerative, 
a  duty  they  must  discharge  under  the  penalty  of  the  for- 
feiture of  their  property  if  they  fail."  1  The  extent  of  the 
burden  which  the  Court  saw  placed  upon  the  carrier  is 
exaggerated.  Only  if  the  return  received  from  operation  is 
less  than  the  cost  of  operating  and  maintaining  the  road- 
bed is  there  any  hardship  imposed  by  reason  of  the  public 
calling.  If  a  company  is  ready  to  forfeit  its  charter  it  has 
the  privilege  of  stopping  operations  entirely.  For  a  time 
it  may  be  necessary  to  operate  at  actual  operating  ex- 
pense greater  than  the  income.  During  such  a  period 
the  railroad's  public  obligation  may  actually  constitute  a 
hardship.  But  the  same  possibility  is  faced  by  any  in- 
dustrial enterprise  which  employs  a  large  fixed  capital  and 
which  seeks  to  keep  its  working  force  together.  Its  plant 
will  not  close  down  so  long  as  the  product  can  be  marketed 
at  a  price  which  covers  the  prime  cost  and  contributes 
something  to  the  overhead  charges,  including  interest  on 
the  investment.  Thus  the  necessity  to  operate  for  less  than 
"full"  cost  does  not,  of  itself,  exist  as  a  burden  present 
only  in  the  railroad  business.  The  public  obligation  simply 
enforces  operation  which  economic  interest  would  impel, 

1  Shepard  v.  N.P.  Ry.  Co.,  184  Fed.  765.  815.  Here  as  elsewhere 
Judge  Sanborn  followed  Mr.  Hill's  testimony.  The  same  "  burden " 
resting  upon  the  railroad  was  the  subject  of  sympathetic  comment  by 
Justice  Brewer  in  Ames  t>.  Union  Pacific,  64  Fed.  165, 177. 


194  RAILROAD  VALUATION 

so  long  as  operating  and  maintenance  charges  were  met. 
To  conjure  up  a  show  of  great  risk  on  this  account  is 
therefore  not  convincing. 

Extremely  intricate  considerations  are  imposed  by  the 
phenomenon  of  a  changing  price  level.  A  change  in  this 
level  affects  the  railroad,  and  therefore  the  railroad  owner, 
in  twofold  fashion.  A  rising  course  of  prices  means  a  mount- 
ing cost  of  operation,  imperiling  the  ability  of  the  railroad 
to  maintain  an  established  rate  of  dividend,  without  con- 
siderable increase  in  the  volume  of  business.  If  the  reverse 
process  sets  in,  larger  dividend  payments  may  be  made. 
In  the  second  place,  the  same  rate  of  dividend  means, 
when  prices  are  advancing,  that  the  actual  purchasing 
power  of  the  security-holder's  income  has  grown  less.  In 
the  period  of  falling  prices,  the  same  rate  means  a  greater 
purchasing  power,  a  larger  "real  income."  Where,  as  in 
the  course  of  the  first  years  of  the  present  century,  a  ris- 
ing level  of  prices  has  been  accompanied  by  a  rise  in  the 
rate  of  interest,  a  further  complication  is  added.  The  bur- 
den in  the  case  of  long-term  securities  has  been  shifted 
to  the  bondholders;  but,  where  new  issues  have  been  put 
out,  either  to  refund  old  issues  or  to  pay  for  new  plant,  the 
result  has  been  to  imperil,  or  at  least  to  threaten,  the  safety 
of  railroad  securities.  Failure  to  correlate  these  various 
aspects  of  the  complicated  economic  problem  has,  it  would 
seem,  weakened  the  presentation  of  the  railroad  pleas  for 
advances.1 

These  have  usually  been  handled  by  lawyers,  or  by 
executives  who,  for  the  most  part,  have  been  operating  and 
financial  officers.  Their  plea  has  consistently  been  that 
"railroad  credit"  was  endangered,  and  not  that  the  rail- 
road security-holder  was  bearing  a  burden  which  should  be 

1  Were  the  reverse  process  to  ensue,  and  were  the  rate  of  interest  and 
the  general  level  of  prices  and  wages  to  fall,  the  opposite  aspects  of  these 
same  considerations  would  demand  careful  investigation.  It  is  enough 
now  simply  to  indicate  the  intricacy  of  the  issues  involved. 


THE  RETURN  TO  THE  RAILROAD  195 

shared  by  the  whole  railroad-using  public.  But  the  fun- 
damental question  of  justice  would  seem  to  concern  the 
security-holder.  In  the  1910  Advance  Cases  the  relation- 
ship of  the  "high  cost  of  living"  to  the  problem  was  barely 
mentioned.1  The  emphasis  was  upon  the  rate  of  income 
necessary  to  induce  new  investors  to  furnish  funds,  not 
upon  the  rate  of  income  which  should  reward  those  invest- 
ors who  had  previously  borne  risks,  etc.  And  when  the 
parties  most  interested  have  failed  to  present  perhaps  the 
strongest  argument  for  their  contention,  it  is  easier  to 
explain  the  unsatisfactory  treatment  of  the  problem  in  the 
decisions  of  the  Interstate  Commerce  Commission.2 

The  same  general  emphasis  upon  "credit"  led  to  the 
reference  to  certain  classes  of  capital  expenditures  as 
"unproductive,"  by  the  Commission  as  well  as  by  the  rail- 
road representatives.  The  narrowing  margin  between  fixed 
charges  and  the  amount  available  for  distribution  in 
dividends  has  not  been  due  to  the  rise  in  the  general  level 
of  prices  and  wages  alone.  The  expanding  volume  of  traffic 
which  has  sought  transportation  has  meant  the  crowding  of 
existing  facilities  to  the  point  of  requiring  double  tracking, 
larger  yards,  heavier  equipment,  etc. 

Though  "increasing  returns"  accrue  during  the  period 
in  which  business  is  "growing  up"  to  the  plant  (the 
phenomenon  is  analogous  to  the  increase  of  urban  site 
rent),  a  point  is  ultimately  reached  where  there  is  a  neces- 

1  Testimony  of  President  McCrea,  of  the  Pennsylvania,  Evidence, 
1910  Advances,  pages  2340-11. 

2  See  the  Eastern  Advance  Case  of  1910,  20 1.C.C.  243,  286-304;  Com- 
missioner Prouty's  discussion  of  the  Baltimore  &  Ohio,  the  New  York 
Central,  and  the  Pennsylvania;  and  the  testimony  of  President  McCrea, 
Evidence,  pages  2329,  2337;  of  President  Ripley,  page  86. 

Commissioner  Daniels'  dissent  in  the  Five  Per  Cent  Case,  though 
recognizing  that  the  "rise  in  price  level  must  eventually  be  reckoned 
with  in  railroading,"  did  not  turn  to  the  relationship  between  the  rate  of 
return  and  the  "real  income"  of  the  security-holder,  31  I.C.C.  350,  454. 
Confusion  of  the  temporary  with  the  "long-run"  rate  of  interest  is  re- 
flected in  Chairman  Harlan's  dissent  in  the  Supplemental  Case,  32  I.C.C. 
325,  336. 


196  RAILROAD  VALUATION 

sity  for  extending  facilities.1  Take  this  "practical  ex- 
ample": The  business  handled  over  the  Central  Pacific 
between  Reno,  Nevada,  and  Sacramento,  —  a  piece  of  line 
with  heavy  grades  and  costly  construction,  where  double- 
tracking  would  require  "a  large  outlay,"  —  increased 
between  1896  and  1907  to  the  crowding  point.  (In  fact, 
testimony  before  the  Commission  was  to  the  effect  that 
additional  traffic  beyond  the  1907  mark  would  have  been 
at  the  expense  of  economical  management.)  Now  assume 
"that  the  Southern  Pacific  had  begun  in  1907  to  double- 
track  this  piece  of  road  and  had  completed  the  work  in  1910 
at  an  expense  of  $100,000  a  mile.  The  amount  of  traffic 
would  not  have  materially  increased.  The  cost  of  main- 
taming  the  road  would  be  greater.  The  cost  of  operation 
would  perhaps  be  somewhat  less,  since  the  business  could 
be  handled  to  better  advantage.  The  net  result  would  be 
practically  the  same,  but  the  cost  of  the  plant  would  have 
been  increased  by  an  amount  requiring  on  a  four  per  cent 
basis  additional  earnings  of  $4000  a  mile."  Commissioner 
Prouty,  in  the  Eastern  Advance  Case  of  1910,  drew  the  con- 
clusion from  this  discussion  (in  terms  of  "there  is  some 
reason  to  believe")  that  the  railroads  in  Official  Classifica- 
tion territory  were  probably  in  the  same  condition  as  the 
Central  Pacific  line  of  the  Southern  Pacific.  A  point  of 
diminishing  returns  had  been  reached  after  twelve  years  of 
"  rapid  and  constant  development  of  business.  The  busi- 
ness of  1907  was,  in  fact,  handled,  but  not  in  a  way  satis- 
factory to  the  public."  2 

Other  factors  which  slow  down  the  tendency  to  the  in- 
crease of  returns  are  less  directly,  though  hardly  less  surely, 
related  to  increase  in  traffic.  They  depend  rather  upon  the 
increased  density  of  population  making  necessary  certain 
classes  of  improvements  which  do  not  immediately  afford 
additional  net  revenue  either  through  increasing  gross 

1  See  F.  W.  Taussig,  Principles  of  Economics,  volume  2,  page  367. 
»  20  I.C.C.  243,  282-83. 


THE  RETURN  TO  THE  RAILROAD  197 

income  or  decreasing  operating  expenses.  But  that  these 
improvements  are  made  only  in  those  centers  of  population 
which  afford  large  traffic,  both  passenger  and  freight,  in- 
dicates that,  looking  at  the  operations  over  a  period  of 
years,  the  "improvement"  is  productive,  as  truly  as  any 
other  portion  of  the  plant.  Take  the  illustration  of  track 
elevation: 

"Years  ago,  when  the  railway  was  constructed,  there  were 
no  buildings  along  its  line,  but  in  process  of  time  a  town  has 
grown  up,  streets  cross  the  track  at  frequent  intervals,  and 
the  municipality  requires  that  the  tracks  be  raised,  and  this 
is  done  at  a  very  considerable  outlay.  Now,  the  railroads 
urge  that  this  improvement  does  not  add  to  the  earning 
capacity  of  the  road.  It  may  save  a  trifle  in  the  way  of  gate- 
men  at  crossings,  and  may  somewhat  reduce  the  casualties 
for  which  the  railroad  is  liable,  but,  on  the  whole,  it  is  an 
expenditure  which  adds  nothing  to  the  net  income  of  the 
railway."  * 

Considered  solely  as  of  a  single  year,  or  of  a  relatively  short 
period  of  years,  the  conclusion  of  this  paragraph  may  be 
accepted.  But  it  overlooks  the  reasons  which  justify  the 
expenditure.  Traffic  has  become  so  dense,  trains  are  so  fre- 
quent, the  town  is  so  large,  that  conditions  of  public  safety 
demand  track  elevation.  And  the  same  forces  which  make 
necessary  the  improvement  normally  bring  larger  gross 
earnings.  The  change  in  income  is,  however,  one  spread 
over  time,  and  is  less  directly  traceable,  and  less  quickly 
seen,  than  where,  for  example,  improvements  to  motive 
power  at  once  bring  lower  operating  cost. 

In  the  case  of  "  unproductive  improvements,"  the  under- 
lying economic  situation  is  not  greatly  different  from  that 
when  a  new  railroad  invades  a  territory  as  a  competitor. 
Not  the  immediate  but  the  ultimate  prospect  furnishes  the 
inducement  to  invest.  Indeed,  if  there  was  never  expecta- 
tion that  the  advantage  secured  would  ultimately  compen- 

1  20  I.C.C.  243,  267.  See  also  Brief  of  Messrs.  Dunlap,  Norton  and 
Lathrop  for  the  Santa  Fe,  Evidence,  1910  Advances,  page  3567. 


198  r  RAILROAD  VALUATION 

sate  the  Pennsylvania  for  the  cost  of  the  Pennsylvania 
Terminal  in  New  York  City  (through  being  in  position  to 
compete  with  the  New  York  Central  on  Manhattan  Is- 
land), it  is  difficult  to  justify  the  project.1  Even  the  "local 
pride"  or  the  "aesthetic  ambition"  of  New  York  does  not 
warrant  such  economic  waste  as,  in  substance,  it  was  testi- 
fied the  New  York  tunnels  and  station  were  believed  to 
represent.2 

Nor  can  the  conclusion  of  the  Railroad  Securities  Com- 
mission be  accepted,  that  the  carriers  should  be  permitted 
to  create  "reserves"  to  provide  "improvements  which  add 
nothing  to  the  earning  capacity  of  the  property  and  ought 
not  to  be  the  basis  of  increased  capital  liability."  3  This 
argument  overlooks  the  manner  in  which  the  return  nor- 
mally accrues  on  fixed  investments.  That  conservative 
business  policy  may  indicate  the  desirability  of  making 
such  improvements  without  adding  to  fixed  charges,  is  not 
per  se  ground  for  insisting  that  the  public  shall  be  asked  to 
advance  rates  above  a  level  compensatory  for  the  old  in- 
vestment. The  economic  justification  for  such  improve- 
ments is  that  the  return  from  the  business  shall  in  the  long 
run  warrant  the  expenditure  made. 

And  yet  the  mutual  dependence  of  railroad  and  public 
interests  is  very  real.  So  long  as  private  enterprise  is 
looked  to  for  the  development  of  transportation  facilities, 
the  railroads  must  be  permitted  to  earn  sufficient  to  make 

1  The  "strategic"  importance  of  adequate  terminals  was  discussed  in 
the  Minnesota  Rate  Cases,  testimony  of  Thomas  Cooper,  Record  (N.P.)» 
pages  134-36,  256-58.   See  also  Manufacturers  Ry.  Co.  ».  St.L.I.M.  &  S. 
Ry.  Co.,  21  I.C.C.  304,  308;  32  I.C.C.  100,  108,  109;  United  States  ». 
Terminal  Association  of  St.  Louis,  224  U.S.  383,  covering  the  St.  Louis 
Terminal  situation. 

2  Testimony  of  President  McCrea,  Evidence,  1910  Advances,  pages 
2296-98.  See  testimony  of  President  Ripley,  of  the  Santa  Fe,  ibid.,  pages 
23-25.    On  the  same  point,  see  also  the  testimony  of  President  Willard, 
of  the  Baltimore  &  Ohio,  page  2359. 

3  Report,  Railroad  Securities  Commission,  page  30.    The  argument 
and  conclusion  suggest  that  the  Commission  is  following  Commissioner 
Prouty's  opinion  in  the  Eastern  Advance  Case  of  1910, 20  I.C.C.  243,  267. 


THE  RETURN   TO   THE   RAILROAD  199 

railroad  investment  attractive.  It  is  this  fact  which  would 
seem  to  invalidate  any  proposal  that  the  rates  be  set'at  a 
level  aiming  to  hew  as  close  to  the  line  of  confiscation  as 
would  stand  the  test  of  court  review.  Though  the  return 
under  a  schedule  of  rates  might  not  be  "so  unreasonably 
low"  as  to  warrant  putting  them  aside  through  process  of 
injunction,  the  return  might  well  fall  short  of  being  "  rea- 
sonable." 

The  public  is  peculiarly  interested  in  the  future  develop- 
ment of  railroad  facilities.  Though  the  additions  to  the  rail- 
road net  will  probably  not  be  as  significant  in  the  future  as 
they  have  been,  even  in  the  more  recent  past,  large  expendi- 
tures must  undoubtedly  be  made  in  the  improvement  of 
existing  lines. 

"As  our  population  grows  denser,  we  shall  need  more  and 
more  to  approximate  European  standards  of  construction 
by  the  increased  amount  of  double  track,  the  abolition  of 
grade  crossings,  the  development  of  station  facilities  both  for 
passengers  and  for  freight,  and  many  other  improvements 
scarcely  less  fundamental.  While  our  railroads  are  perhaps 
even  better  equipped  than  those  of  Europe  for  the  economi- 
cal handling  of  large  masses  of  long  distance  freight,  they  are 
far  from  being  adequately  provided  with  appliances  to  secure 
the  convenience  of  the  public  or  the  safety  of  passengers  and 
employees."  l 

The  public  body  which  regulates  rates  must  therefore 
look  to  the  adequacy  of  the  railroad  revenue,  with  an  eye 
to  making  investment  in  railroad  securities  attractive  to 
the  investor  in  future  years.  An  uncertain  minimum  level 
of  charges  is  thus  established. 

But  promise  of  a  profit  greater  than  that  now  needed 
in  order  to  attract  investment  in  a  well-established  railroad 
was  originally  necessary  in  order  to  attract  investors  of  an 
earlier  day  who  undertook  pioneer  risks.  Once  the  enter- 
prise has  become  profitable,  and  the  risk  in  part  eliminated 
1  Report,  Railroad  Securities  Commission,  page  35. 


200  RAILROAD  VALUATION 

for  future  investors,  shall  it  be  conceived  that  a  return 
sufficient  to  attract  this  future  investment  is  reasonable, 
that  anything  more  than  this  amount  represents  excessive 
profit?  l  Less  than  this  would  mean  a  check  to  railroad 
enterprise  and  to  the  further  development  of  facilities. 
But  can  it  be  said  that  this  minimum,  so  broadly  stated, 
represents  a  reasonable  return  under  the  set  of  circum- 
stances to  be  considered,  that  anything  in  excess  represents 
extortion  —  "monopoly  profit"?  On  the  contrary,  there 
are  circumstances  when  a  reasonable  return  is  something 
more  than  "one  which  under  honest  accounting  and  re- 
sponsible management  will  attract  the  amount  of  investors* 
money  needed  for  the  development  of  our  railroad  facilities." 
More  than  this  is  not  always  "an  unnecessary  public 
burden,"  even  though  it  be  granted,  with  the  Securities 
Commission,  that  "less  than  this  means  a  check  to  railroad 
construction."  2  And  the  conclusion  follows  because  so 
considerable  a  portion  of  railroad  investment  represents 
pioneer  risks. 

The  issue  can  be  illustrated  also  by  reference  to  that 
passage  in  Marshall's  Principles  of  Economics  where  the 
"creation"  of  "economic  rent"  is  discussed:  "Sometimes 
the  settlement  of  a  whole  town,  or  even  district,  is  planned 
on  business  principles,  and  carried  out  as  an  investment  at 
the  expense  and  risk  of  a  single  person  or  company."  Such 
a  case  was  the  founding  of  Pullman  which  he  cites,  or  of 
Gary,  Indiana,  the  great  steel  town.  The  business  execu- 
tives who  planned  these  industrial  centers  "foresaw  that 
the  land,  which  they  could  purchase  at  its  value  for  agri- 
cultural purposes,"  —  the  site  of  Gary  was  practically 
worthless  sandy  lake  shore,  —  "  would  obtain  the  special 

1  This  would  seem  to  be  the  purport  of  Commissioner  Prouty's  dis- 
cussion in  the  Eastern  Advance  Case  of  1910,  20  I.C.C.  243,  263. 

2  Report,  Railroad  Securities  Commission,  page  36.  See,  however,  testi- 
mony of  President  Willard  of  the  Baltimore  &  Ohio,  Evidence,  1910  Ad- 
vances, pages  2398,  2399;  illustrating  that  the  railroads  did  not,  as  it 
would  seem,  make  the  most  of  the  logic  of  their  position. 


THE  RETURN  TO  THE  RAILROAD          201 

situation  value  which  town  property  derives  from  the  im- 
mediate neighborhood  of  a  dense  population.  ...  In  all 
such  cases,  the  yearly  income  derived  from  the  land  (or  at 
all  events  that  part  of  it  which  is  in  excess  of  the  agricultural 
rent)  is  for  many  purposes  to  be  regarded  as  profits  rather 
than  rent.  .  .  .  For  in  such  cases  great  risks  have  to  be 
run;  and  hi  all  undertakings  in  which  there  are  risks  of 
great  losses,  there  must  also  be  hope  of  great  gains."  1 

Apply  this  same  general  line  of  reasoning  to  the  railroad. 
It  owns  a  site,  which  its  purchase  withdrew  from  agricul- 
tural or  other  business  use.  A  considerable  "fixed  invest- 
ment" has  been  made  once  for  all  in  grading  a  suitable 
roadbed.  If  the  railroad  fails  to  warrant  construction — 
if  abandonment  follows  (sometimes  even  this  occurs)  —  the 
investment  is  lost  for  all  time.  Or,  in  the  case  of  lesser  ill- 
success,  when  it  is  found  that  operation  nets  something 
above  operating  expenses,  though  less  than  the  anticipated 
return,  the  company  must  bear  the  burden  of  loss.  The 
volume  of  traffic  seeking  transportation  determines  whether 
the  railroad  shall  pay,  or  shall  stand  as  a  financial  failure. 
But,  at  the  beginning  of  the  venture,  the  prospect  of  return 
must  be  sufficiently  attractive  to  tempt  the  investor  to 
assume  the  risk  and  responsibility  of  planning,  construct- 
ing, operating.  In  the  long  run,  and  over  the  whole  field 
of  railroad  enterprise,  there  must  be  successful  ventures  in 
order  that  a  continuous  flow  of  capital  and  business  abil- 
ity may  be  directed  toward  transportation. 

"The  normal  expenses  of  production  of  a  commodity  must 
include  payment  for  the  ventures  required  for  producing  it, 
sufficient  to  cause  those  who  are  on  the  margin  of  doubt 
whether  to  venture  or  not,  to  regard  the  probable  net  amount 
of  their  gains  —  net,  that  is,  after  deducting  the  probable 
amount  of  their  losses  —  as  compensating  them  for  their 
trouble  and  their  outlay."  2 

1  Alfred  Marshall,  Principles  of  Economics,  pages  442-43;  see  F.  W. 
Taussig,  Principles  of  Economics,  volume  2,  page  89. 

8  Alfred  Marshall,  Principles  of  Economics,  page  443.  Failure  to  recop- 


203  RAILROAD  VALUATION 

One  further  point:  existing  railroads  do  not  represent 
the  same  exercise  of  judgment  in  original  planning,  the 
same  efficiency  in  creating  and  maintaining  an  organiza- 
tion, in  establishing  relations  with  shippers  and  passen- 
gers, in  solving  operating  problems.  Clearly  focused  are 
seen  the  forces  which  make  for  the  differential  element 
in  "business  profits."  The  mode  in  which  this  differential 
accrues  to  the  better  located,  better  managed  roads  can 
be  readily  indicated.1  Location  is  important  from  two 
points  of  view:  from  that  of  ability  to  secure  large  gross 
earnings,  and  from  that  of  economical  transportation  of 
the  traffic  secured.  The  latter  refers  simply  to  the  physical 
characteristics:  to  "strategic  location"  in  a  river  gorge,  to 

nize  the  return  to  the  investor  as  entering  into  the  long-run  cost  of  pro- 
ducing transportation  service  accounts  for  the  frequent  insistence  that 
there  is  no  relation  between  "valuation"  and  rates.  The  following  is  a 
typical  utterance: 

"It  is  perfectly  obvious  that  the  railroad  rates  of  this  country  are  not 
based  on  the  value  of  railroad  property.  No  railroad  has  ever  undertaken 
to  base  rates  on  the  value  of  its  property,  and  no  railroad  man  has  ever 
attempted  to  make  rates  according  to  the  value  of  the  railroad."  From 
the  statement  of  R.  S.  Lovett,  before  the  Railroad  Securities  Commission, 
1910,  in  "Sayings  and  Writings  about  the  Railroads,"  published  by  the 
Railway  Age  Gazette,  page  109.  See  testimony  of  F.  A.  Delano,  before  the 
Senate  Committee  on  Interstate  Commerce,  Senate  Report  on  Valuation, 
page  45;  and  that  of  E.  P.  Ripley,  Evidence,  1910  Advances,  page  58. 

1  See  discussion  of  "market  value,"  above,  page  150.  The  failure  to  see 
that  the  reasonable  return  could  be  a  variable  was  undoubtedly  at  the 
basis  of  the  "market  value"  test.  Witness  the  following  from  Mr.  Law- 
rence's Report  to  the  National  Association  of  Railway  Commissioners, 
Proceedings,  22d  Annual  Meeting,  page  144: 

"  The  determination  of  market  value  as  a  basis  for  rate-making  solves 
impossible  problems.  Take,  for  instance,  two  competing  roads  between 
the  same  terminals,  one  on  a  direct  line  and  the  other  circuitous,  the 
latter  costing  very  much  more  to  construct,  or  reproduce.  It  is  apparent 
that  competition  will  force  an  equality  in  rates.  How,  under  the  theory 
of  actual  cost  or  cost  of  reproduction,  can  the  rates  be  fixed  without  al- 
lowing an  excess  on  the  one  hand,  or  a  deficiency  on  the  other?  Apply 
the  theory  of  market  value.  The  road  with  the  direct  line,  lower  cost 
of  reproduction,  and  relatively  lower  operating  expenses  is  of  a  higher 
market  value  under  the  circumstances." 

Essentially  the  same  argument  is  used  by  S.  O.  Dunn,  American  Trans- 
portation Question,  page  93  and  following. 


THE  RETURN  TO  THE  RAILROAD  203 

the  possession  of  a  water-level  route — which  mean  a  lower 
ruling  grade,  less  curvature,  and  therefore,  other  things 
being  equal,  a  larger  margin  between  operating  expenses 
and  revenue  than  would  be  possible  were  the  road  operated 
through  the  hills  or  mountains.  It  is  the  old  question  of  the 
New  York  Central  and  the  Pennsylvania,  the  one  operating 
through  river  valleys  and  along  the  lake  shore,  going  around 
the  mountains,  the  other  cutting  through.  An  extra  gain 
comparable  to  a  site  rent  appears,  as  a  reward  for  skill 
in  original  location,  —  perhaps  even  for  the  one  company 
having  first  dared  risk  the  cost  of  building. 

Location  has  also  an  important  bearing  upon  the  quan- 
tity and  classification  of  freight  transported,  and  upon  the 
density  of  the  passenger  traffic;  and,  consequently,  upon 
the  amount  of  the  gross  earnings.  Much  necessarily  de- 
pends upon  the  natural  resources  of  the  tributary  country, 
but  not  everything.  In  considerable  degree  the  presence 
of  industries  is  the  result  of  active  management  which 
has  secured  the  location  of  industries  along  the  line  of 
the  road.  Once  an  industrial  community  has  been  started, 
the  gregariousness  of  industry  has  made  itself  felt  by 
further  grouping  of  similar  plants  in  the  same  district.  But 
efficient  management  in  seeking  out  businesses  for  loca- 
tions, and  locations  for  businesses,  and  in  establishing 
favorable  rates  has  been  a  not  inconsiderable  factor  in 
increasing  the  "traffic  density"  of  the  railroads.  Similarly 
the  policy  of  bringing  settlers  to  a  new  country,  inaugu- 
rated on  a  large  scale  by  the  Illinois  Central,  has  been 
followed  as  other  lines  have  been  built  into  the  newer 
West.  Populations  have  been  built  up,  in  part  the  direct 
result  of  efforts  by  the  railroad  management,  in  part  the 
result  of  "social"  and  economic  forces. 

The  railroad  in  a  country  increasing  in  population  and 
in  "diversity"  of  the  business  afforded  (and  this  is  not 
necessarily  a  "new"  country,  though  the  phenomenon  is 
there  most  strikingly  seen)  finds  the  swelling  prosperity 


204  RAILROAD  VALUATION 

of  the  tributary  country  reflected  in  the  volume  of  its  own 
gross  earnings.  Once  the  net  earnings  extend  beyond  the 
point  which  was  necessary  to  induce  the  original  invest- 
ment, an  element  of  "unearned  increment"  appears  com- 
parable to  the  "unearned  increment"  accruing  on  sites 
devoted  to  other  than  railroad  purposes.  From  the  nature 
of  the  case,  it  is  difficult  to  say  when  the  volume  of  net 
earnings  exceeds  the  rate  necessary  to  tempt  investment. 
In  those  enterprises  hi  which  there  are  risks  of  great  losses 
—  surely  railroad  history  would  seem  to  bear  out  the  in- 
clusion of  railroads  in  this  category  of  ventures  —  there 
must  be  hope  of  great  gain.  Even  though  the  source  of 
the  differential  may  be  indicated  as  due  to  natural  condi- 
tions (a  "water  grade,"  or  the  possession  of  a  canyon  pass, 
for  example),  to  "social"  causes  (the  increasing  of  popula- 
tion, the  clustering  together  of  allied  branches  of  indus- 
try), or  primarily  as  due  to  superior  management,  the 
actual  income  is  a  resultant  of  these  forces.  The  "legiti- 
mate" differential  return  in  profits,  whether  due  to  judg- 
ment in  picking  an  original  line  which  possesses  superior 
operating  conditions,  or  to  subsequent  active  management 
in  building  up  an  efficient  organization,  or  in  establishing 
satisfactory  relations  with  the  shipping  and  traveling 
public,  is  intermingled  with  any  return  above  the  costs 
necessary  to  induce  promotion  and  management  of  high 
grade.  To  bring  American  railroad  service  to  its  present  pre- 
eminent place  has  required  courage,  imagination,  skill  of 
the  highest  order.  The  emphasis  upon  the  important  in- 
vestments in  railroad  plant  which  are  now  being  made  — 
track  elevation,  passenger  terminals  —  as  "unproductive" 
indicates  the  presence  still  of  a  considerable  risk  element. 
In  the  light  of  the  composite  nature  of  the  railroad  return, 
it  would,  therefore,  appear  well-nigh  impossible  to  isolate 
an  element  of  "unearned  increment."  l 

Entirely  aside  from  the  issue  of  the  practicability  of 
1  See  F.  W.  Taussig,  Principles  of  Economics,  volume  2,  page  98. 


THE  RETURN  TO  THE  RAILROAD  205 

disassociating  an  element  of  "unearned  increment'*  in  the 
return  to  the  railroad,  is  a  broader  challenge  which  looks 
to  the  validity  of  appropriating  this  increment  either 
through  taxation  or  reduction  of  charges.  The  power 
of  regulation,  alone,  hardly  warrants  reduction  of  rates 
simply  because  the  tendency  exists  for  railroad  net  earn- 
ings to  increase  in  proportion  to  the  investment.1  That 
the  railroad  is  a  common  carrier,  that  the  furnishing  of 
transportation  is  a  "public"  business,  only  accounts  for 
regulation.  By  itself  it  does  not  justify  a  deliberate  at- 
tempt to  capture  the  "unearned  increment"  on  one  class 
of  sites.  To  appropriate  the  "unearned  increment"  (if 
any)  which  accrues  to  the  railroad  with  the  increase  of 
traffic  may  represent  a  desirable  policy  for  the  community 
to  adopt.  But  that  it  is  more  desirable  than  the  appro- 
priation of  the  "unearned  increment"  which  accrues  in 
the  rent  of  lands  devoted  to  other  purposes  one  may  well 
be  skeptical. 

1  See  William  Z.  Ripley,  Railroads,  Finance  and  Organization,  pages 
361-62,  a  discussion  of  this  subject  from  a  different  standpoint;  also 
Professor  Ripley's  article  in  the  Political  Science  Quarterly,  volume  22, 
page  606  and  following. 

Henry  C.  Adams,  long  the  Commission's  Statistician,  the  man  to 
whom,  perhaps  more  than  any  other,  the  force  of  the  "valuation"  move- 
ment is  due,  has  expressed  his  conclusion  that  "equity  as  between  various 
classes  of  roads  can  never  be  attained  until  all  the  excess  of  revenue  over  the 
constitutional  limit  be  made  a  contribution  to  the  public  treasury." 
Papers  and  Discussions,  22d  Annual  Meeting  American  Economic  Asso- 
ciation, 1909,  page  193.  (The  italics  are  the  writer's.)  See  his  annual 
recommendations  to  the  Commission,  Statistics  of  Railways,  1906,  page 
140;  1907,  page  147,  etc. 


THE  END 


BIBLIOGRAPHY 

THE  principal  sources  for  a  study  of  Railroad  Valuation  are  the 
reports  of  cases,  since  it  is  as  a  legal  problem  that  the  subject  has 
crystallized.  Whitten's  Valuation  of  Public  Service  Corporations, 
though  containing  some  of  the  author's  own  reasoning,  is  sub- 
stantially a  source  book  on  the  subject,  composed  of  short  ex- 
cerpts from  cases,  articles,  and  reports  upon  controverted  points. 
Naturally,  therefore,  the  book  is  uneven  in  the  quality  of  the 
material  which  it  affords  the  student.  The  point  of  view  of  the 
original  material  is  very  like  that  of  the  Public  Service  Commis- 
sion of  New  York,  First  District.  The  Transactions  and  Pro- 
ceedings of  the  American  Society  of  Civil  Engineers  indicate  the 
quality  and  direction  of  the  engineering  discussion  of  the  subject. 

On  the  Federal  Valuation,  the  various  briefs  filed  with  the 
Commission  should  be  consulted,  especially  that  filed  on  behalf 
of  the  railroad  companies  represented  by  the  Presidents'  Confer- 
ence Committee,  here  cited  as  the  Valuation  Brief  of  1915.  The 
publications  of  the  Division  of  Valuation  are  also  important, 
and  those  of  the  General  Secretary  of  the  Presidents'  Conference 
Committee,  especially  the  Proceedings  of  the  various  valuation 
conferences  between  representatives  of  the  carriers,  the  State 
commissions,  and  the  Interstate  Commerce  Commission. 

GENERAL  WORKS  AND  PAMPHLETS 

Allison,  J.  E.,  Should  Public  Service  Properties  Be  Depreciated  ? 

Dunn,  Samuel  O.,  American  Transportation  Question. 

Dunn,  Samuel  O.,  Current  Railway  Problems. 

Floy,  Henry,  Valuation  of  Public  Utility  Properties. 

Foster,  Horatio  A.,  Engineering  Valuation  of  Public  Utilities. 

Hammond,  M.  B.,  Railway  Rate  Theories  of  the  Interstate  Com- 
merce Commission. 

Hayes,  Hammond  V.,  Public  Utilities,  Their  Cost  New  and  De- 
preciation. 

Lawrence,  John  C.,  Reasonable  Railway  Rates. 

Lyon,  W.  H.,  Capitalization. 

Ripley,  William  Z.,  Railroads :  Finance  and  Organization. 


208  BIBLIOGRAPHY 

Smalley,  Harrison,  Railroad  Rate  Control. 

Wellington,  A.  M.,  Economic  Theory  of  Railway  Location. 


ARTICLES  IN  PERIODICALS 

Adams,  Henry  C.,  "Valuation  of  Public  Service  Utilities,"  Ameri- 
can Economic  Association  Quarterly ,  volume  11,  page  184. 

Allison,  James  E.,  "Ethical  and  Economic  Elements  in  Public 
Service  Valuation,"  Quarterly  Journal  of  Economics,  volume 
27,  page  27. 

Baker,  J.  E.,  "Valuation  of  Terminal  Lands, "  Journal  of  Account- 
ancy, volume  8,  page  239. 

Bauer,  John,  "Depreciation  and  Rate  Control,"  Quarterly  Jour- 
nal of  Economics,  volume  29,  page  362. 

Berglund,  Abraham,  "Valuation  of  Railroads  in  Washington," 
Journal  of  Political  Economy,  volume  21,  page  332. 

Bonbright,  James  C.,  "Depreciation  and  Rate  Control,"  Quar- 
terly Journal  of  Economics,  volume  30,  page  546. 

Butler,  Pierce,  "Valuation  of  Railway  Property  for  Purposes  of 
Rate  Regulation,"  Journal  of  Political  Economy,  volume  23, 
page  17. 

Davis,  Joseph  S.,  "Depreciation  and  Rate  Control,"  Quarterly 
Journal  of  Economics,  volume  29,  page  362. 

Delano,  F.  A.,  "The  Application  of  a  Depreciation  Charge,"  etc., 
Journal  of  Political  Economy,  volume  16,  page  585. 

Dunn,  Samuel  O.,  "The  Valuation  of  Railways,"  Atlantic 
Monthly,  volume  113,  page  403. 

Gray,  John  H.,  "The  Vagaries  of  Valuation,"  American  Economic 
Review,  volume  4,  page  18. 

Hammond,  M.  B.,  "Recent  Efforts  to  Advance  Freight  Rates," 
American  Economic  Review,  volume  1,  page  766. 

Hansel,  Charles,  "State  Valuation  of  Railroads,"  North  American 
Review,  volume  185,  page  485. 

Hayes,  Hammond  V.,  "  Original  Cost  versus  Replacement  Cost," 
etc.,  Quarterly  Journal  of  Economics,  volume  27,  page  616. 

Heilman,  Ralph  E.,  "Principles  of  Public  Utility  Valuation," 
Quarterly  Journal  of  Economics,  volume  28,  page  269. 

Reynolds,  Jackson  E.,  "Railway  Valuation,  Is  it  a  Panacea?" 
Columbia  Law  Review,  volume  8,  page  265. 

Riggs,  H.  E.,  "Valuation  of  Public  Service  Corporation  Prop- 
erty," Transactions,  Am.  Soc.,  C.E.,  volume  72,  page  1. 

Riggs,  R.  E.  T.,  "Problems  of  Railroad  Valuation,"  Columbia 
Law  Review,  volume  13,  page  582. 


BIBLIOGRAPHY  209 

Ripley,  Edward  P.,  "The  Railroads  and  the  People,"  Atlantic 
Monthly,  volume  107,  page  12. 

Ripley,  William  Z.,  "Physical  Valuation  of  Railroads,"  Political 
Science  Quarterly,  volume  29,  page  569. 

Robinson,  M.  H.,  "The  Legal,  Economic,  and  Accounting  Prin- 
ciples involved  in  the  Judicial  Determination  of  Railway  Pas- 
senger Rates,"  Yale  Review,  volume  16,  page  355. 

Robinson,  M.  H.,  "Railway  Freight  Rates,"  Yale  Review,  vol- 
ume 18,  page  122. 

Sakolski,  A.  M.,  "Valuation  of  Railroad  Right  of  Way,"  American 
Economic  Review,  volume  6,  page  288. 

Swayze,  Francis  J.,  "Regulation  of  Railway  Rates,  under  the 
Fourteenth  Amendment,"  Quarterly  Journal  of  Economics, 
volume  26,  page  389. 

Taussig,  F.  W., "  A  Contribution  to  the  Theory  of  Railway  Rates," 
Quarterly  Journal  of  Economics,  volume  5,  page  438. 

Thelen,  Max,  "Public  Utility  Rates,  a  Just  and  Scientific  Basis," 
etc.,  California  Law  Review,  volume  2,  page  1. 

WTiitten,  R.  H.,  "Fair  Value  for  Rate  Purposes,"  Harvard  Law 
Review,  volume  27,  page  419. 

Young,  Allyn  A.,  "Depreciation  and  Rate  Control,"  Quarterly 
Journal  of  Economics,  volume  28,  page  630;  volume  29,  pages 
378,  395. 

CASES 
I.  United  States  Supreme  Court 

Adams  Express  Co.  v.  Ohio,  166  U.S.  185  (1897). 

Allen  et  al.  v.  St.L.I.M.  &  S.  Ry.  Co.,  230  U.S.  553  (1913). 

Atlantic  Coast  Line  R.R.  Co.  v.  N.C.  Corporation  Commission, 

206  U.S.  1  (1907). 

Boom  Co.  v.  Patterson,  98  U.S.  403  (1878). 
Budd  r.  New  York,  143  U.S.  517  (1892). 
Cedar  Rapids  G.L.  Co.  v.  Cedar  Rapids,  223  U.S.  655  (1912). 
Chicago  &  G.T.  Ry.  Co.  v.  Wellman,  143  U.S.  339  (1892). 
Chicago,  B.  &  Q.  R.R.  Co.  v.  Iowa,  94  U.S.  155  (1876). 
Chicago,  M.  &  St.P.  Ry.  Co.  v.  Minnesota,  134  U.S.  418  (1890). 
^Chicago,  M.  &  St.P.  Ry.  Co.  v.  Tompkins,  176  U.S.  167  (1900). 
Cleveland,  C.C.  &  St.L.  Ry.  Co.  v.  Backus,  154  U.S.  439  (1894). 
Cotting  t?.  Kansas  City  S.Y.  Co.,  183  U.S.  79  (1901). 
Covington  &  Lexington  T.P.  Co.  v.  Sandford,  164  U.S.  578  (1896). 
Dow  v.  Biedelman,  125  U.S.  680  (1888). 
Ex  parte  Young,  209  U.S.  123  (1908). 


210  BIBLIOGRAPHY 

Georgia  Banking  Co.  ».  Smyth,  128  U.S.  174  (1888). 
Granger  Cases,  94  U.S.  113  (1876). 
Illinois  Central  R.R.  Co.  v.  I.C.C.,  206  U.S.  441  (1907). 
Interstate  Commerce  Commission  v.  C.N.O.  &  T.P.  Ry.  Co.,  167 

U.S.  479  (1897). 

Kansas  City  Southern  Ry.  Co.  v.  U.S.,  231  U.S.  423  (1913). 
Knoxville  v.  Knoxville  Water  Co.,  212  U.S.  1  (1909). 
KnoxviUe  Water  Co.  v.  KnoxvUle,  189  U.S.  434  (1903). 
Lake  Shore  &  M.S.  Ry.  Co.  v.  Smith,  173  U.S.  684  (1899). 
Lincoln  G.  &  E.  Co.  v.  Lincoln,  223  U.S.  349  (1912). 
Louisiana  R.R.  Commission  v.  Cumberland  T.  &  T.  Co.,  212 

U.S.  414  (1909). 
Minneapolis  &  St.  Louis  R.R.  Co.  v.  Minnesota,  186  U.S.  257 

(1902). 

Minnesota  Eastern  Ry.  Co.  v.  Minnesota,  134  U.S.  467  (1890). 
Minnesota  Rate  Cases,  230  U.S.  352  (1913). 
Missouri  Rate  Cases,  230  U.S.  474  (1913). 
Monongahela  Navigation  Co.  v.  U.S.,  148  U.S.  312  (1893). 
Munn  v.  Illinois,  94  U.S.  113  (1876). 

Norfolk  &  Western  Ry.  Co.  v.  Conley,  236  U.S.  605  (1915). 
Northern  Pacific  Ry.  Co.  v.  N.D.,  216  U.S.  579  (1910). 
Northern  Pacific  Ry.  Co.  v.  N.D.,  236  U.S.  585  (1915). 
Northern  Pacific  Ry.  Co.  v.  Townsend,  190  U.S.  267  (1903). 
Omaha  v.  Omaha  Water  Co.,  218  U.S.  180  (1910). 
Peik  v.  C.  &  N.W.  Ry.  Co.,  94  U.S.  164  (1876). 
Pittsburgh,  C.C.  &  St.L.  Ry.  Co.  v.  Backus,  154  U.S.  421  (1894), 
Prentis  et  al.  v.  A.C.L.  R.R.  Co.,  211  U.S.  210  (1908). 
Railroad  Commission  Cases,  116  U.S.  307  (1886). 
Reagan  v.  Farmers'  Loan  &  Trust  Co.,  154  U.S.  362  (1894). 
Reagan  v.  Mercantile  Trust  Co.,  154  U.S.  413  (1894). 
St.  Louis  &  S.F.  Ry.  Co.  v.  Gill,  156  U.S.  649  (1895). 
San  Diego  L.  &  T.  Co.  v.  Jasper,  189  U.S.  439  (1903). 
San  Diego  L.  &  T.  Co.  v.  National  City,  174  U.S.  739  (1899). 
Smyth  v.  Ames,  169  U.S.  466  (1898). 
Smyth  v.  Ames,  171  U.S.  361  (1898). 
Stanislaus  County  v.  San  J.  &  K.R.  Canal  Co.,  192  U.S.  201 

(1904). 

Stone  v.  Farmers*  Loan  &  Trust  Co.,  116  U.S.  307  (1886). 
Willcox  v.  Consolidated  Gas  Co.,  212  U.S.  19  (1909). 

The  full  Record  was  consulted  in  the  following  cases: 
Knoxville  9.  Knoxville  Water  Co.,  212  U.S.  1. 
Minnesota  Rate  Cases,  230  U.S.  352. 


BIBLIOGRAPHY  211 

Missouri  Rate  Cases,  230  U.S.  474. 
Railroad  Commission  Cases,  116  U.S.  307. 
Smyth  v.  Ames,  169  U.S.  466. 
Willcox  v.  Consolidated  Gas  Co.,  212  U.S.  19. 

77.  United  States  Circuit  and  District  Courts 

Ames  v.  Union  Pacific  Ry.  Co.,  64  Fed.  165  (1894). 

Arkansas  Railroad  Rates,  In  re,  163  Fed.  141  (1908);  168  Fed. 

720  (1909);  187  Fed.  290  (1911). 
Ball  v.  Rutland  R.R.  Co.,  93  Fed.  513  (1899). 
Central  of  Georgia  Ry.  Co.  v.  McLendon,  157  Fed.  961  (1907). 
Central  of  Georgia  Ry.  Co.  v.  R.R.  Commission  of  Alabama, 

161  Fed.  925  (1908). 

Chicago  &  N.W.  Ry.  Co.  v.  Dey,  35  Fed.  866  (1888). 
Chicago,  M.  &  St.P.  Ry.  Co.  v.  Tompkins,  90  Fed.  363  (1898). 
Clyde  v.  Richmond  &  Danville  R.R.  Co.,  57  Fed.  436  (1893). 
Consolidated  Gas  Co.  v.  City  of  New  York,  157  Fed.  849  (1907). 
Cotting  v.  Kansas  City  S.Y.  Co.,  79  Fed.  679  (1897);  82  Fed.  839 

(1897). 

Cumberland  T.  &  T.  Co.  9.  LouisviUe,  187  Fed.  637  (1911). 
Cumberland  T.  &  T.  Co.  v.  R.R.  Commission  of  Louisiana,  156 

Fed.  823  (1907). 

Lehigh  Valley  Railroad  9.  U.S.,  204  Fed.  986  (1913). 
Louisville  &  Nashville  R.R.  Co.  v.  Brown,  123  Fed.  946  (1903). 
Louisville  &  Nashville  R.R.  Co.  9.  R.R.  Commission  of  Alabama, 

157  Fed.  944  (1907);  196  Fed.  800  (1912);  208  Fed.  35  (1913). 
Louisville  &  Nashville  R.R.  Co.  9.  R.R.  Commission  of  Tennessee, 

19  Fed.  679  (1884). 

LouisviUe  &  Nashville  R.R.  Co.  f.  Siler,  186  Fed.  176  (1911). 
Love  v.  A.T.  &  S.F.  Ry.  Co.,  185  Fed.  321  (1911). 
Matthews  v.  Board  of  Corporation  Commissioners,  106  Fed.  7 

(1901). 
Metropolitan  Trust  Co.  9.  Houston  &  Texas  Central  R.R.  Co., 

90  Fed.  683  (1898). 

Milwaukee  E.R.  &  L.  Co.  ».  Milwaukee,  87  Fed.  577  (1898). 
Minnesota  Rate  Cases,  184  Fed.  765  (1911). 
Missouri,  Kansas  &  Texas  Ry.  Co.  9. 1.C.C.,  164  Fed.  645  (1908). 
Missouri,  Kansas  &  Texas  Ry.  Co.  9.  Love,  177  Fed.  493  (1910). 
National  Water  Works  Co.  9.  Kansas  City,  62  Fed.  853  (1894). 
Northern  Pacific  Ry.  Co.  v.  Keyes,  91  Fed.  47  (1898). 
Northern  Pacific  Ry.  Co.  v.  Lee,  199  Fed.  621  (1912). 
Oregon  R.  &  N.  Co.  9.  Campbell,  173  Fed.  957  (1909). 


212  BIBLIOGRAPHY 

Perkins  v.  Northern  Pacific  Ry.  Co.,  155  Fed.  445  (1907). 
Railroad  Commission  of  Alabama  v.  Central  of  Georgia  Ry.  Co., 

170  Fed.  225  (1909). 
St.  Louis  &  S.F.  R.R.  Co.  v.  Hadley,  155  Fed.  220  (1907);  168 

Fed.  317  (1909). 

San  Diego  L.  &  T.  Co.  v.  Jasper,  110  Fed.  702  (1901). 
San  Diego  L.  &  T.  Co.  v.  National  City,  74  Fed.  79  (1896). 
Shepard  v.  Northern  Pacific,  184  Fed.  765  (1911). 
Spring  Valley  Water  Co.  v.  San  Francisco,  165  Fed.  657  (1904). 
Spring  Valley  Water  Works  Co.  v.  San  Francisco,  124  Fed.  574 

(1903).     - 
Texas  &  Pacific  Ry.  Co.  v.  R.R.  Commission  of  Louisiana,  192 

Fed.  280  (1911). 

Tffley  v.  Savannah,  Florida  &  Western  Ry.  Co.,  5  Fed.  641  (1881). 
Trust  Co.  of  America  v.  C.P.  &  St.L.  Ry.  of  111.,  199  Fed.  593 

(1912). 
Western  Ry.  of  Alabama  v.  R.R.  Commission  of  Alabama,  197 

Fed.  954  (1912). 

The  Reports  of  Special  Masters  of  the  United  States  Courts 

were  consulted  as  follows: 

Gunter,  W.  A.,  The  Alabama  Rate  Cases:  South  &  North  Ala- 
bama R.R.  Co.  v.  R.R.  Commission  of  Alabama;  Louisville 
&  Nashville  R.R.  Co.  v.  Same  (1911). 

Hasten,  A.  H.,  Consolidated  Gas  Co.  v.  Mayer  (Record,  Willcox 
v.  Consolidated  Gas  Co.). 

Otis,  Chas.  E.,  The  Minnesota  Rates  Cases. 

Thorington,  W.  S.,  The  Alabama  Rate  Cases:  Central  of  Georgia 
Ry.  Co.  v.  R.R.  Commission  of  Alabama;  Western  Ry.  of  Al- 
abama v.  Same  (1912). 

III.  State  Courts 

Brunswick  Water  District  v.  Maine  Water  Co.,  99  Maine  371 

(1904). 

Brymer  v.  Butler  Water  Co.,  179  Penn.  231  (1897). 
Coal  &  Coke  Ry.  Co.  v.  Conley,  67  Southeastern  613  (1910). 
Kennebec  Water  District  v.  City  of  WaterviUe,  97  Maine  185 

(1902). 
Kings  County  Lighting  Co.  v.  Willcox,  156  App.  Div.  N.Y.  603 

(1913). 
Pennsylvania  R.R.  Co.  v.  Philadelphia  County,  220  Penn.  100 

(1908). 


BIBLIOGRAPHY  213 

Pioneer  T.  &  T.  Co.  v.  Westenhaver,  118  Pacific  354  (1911). 
Public  Service  Gas  Co.  v.  Board  of  Public  Utility  Commissioners, 
87  Atlantic  651  (1913);  92  Atlantic  606  (1914);  94  Atlantic 
634  (1915). 

San  Diego  Water  Co.  v.  San  Diego,  118  Cal.  556  (1897). 
Steenerson  v.  Great  Northern  Ry.  Co.,  72  Northwestern  713 
(1897). 

* 
IV.  Interstate  Commerce  Commission 

Advances,  in  the  Matter  of,  9  I.C.C.  382  (1903). 

Advances,  in  the  Matter  of,  "The  1910  Advance  Cases";  Eastern 

Case,  20  I.C.C.  243;  Western  Case,  20  I.C.C.  307  (1911). 
Boileau  v.  Pittsburgh  &  Lake  Erie  R.R.  Co.,  22  I.C.C.   640 

(1912). 
Central  Yellow  Pine  Association  v.  Illinois  Central  R.R.  Co.,  10 

I.C.C.  505  (1905). 

Five  Per  Cent  Case,  31  I.C.C.  350;  32  I.C.C.  325  (1914). 
Lum  v.  Great  Northern  Ry.  Co.,  33  I.C.C.  541  (1915). 
Morgan  Grain  Co.  v.  Atlantic  Coast  Line  R.R.  Co.,  19  I.C.C.  471 

(1910). 
Portland  Chamber  of  Commerce  v.  Oregon  Ry.  &  Nav.  Co.,  19 

I.C.C.  265  (1910). 
Pulp  and  Paper  Manufacturers  Association  v.  C.M.  &  St.  P.  Ry. 

Co.,  34  I.C.C.  500  (1915). 
Railroad  Commission  of  Texas  v.  A.T.  &  S.F.  Ry.  Co.,  20  I.C.C. 

473  (1911). 
Receivers  &  Shippers  Association  v.  C.N.O.  &  T.P.  Ry.  Co.,  18 

I.C.C.  440  (1910). 
Sheridan  Chamber  of  Commerce  v.  C.B.  &  Q.  R.R.  Co.,  28  I.C.C. 

402  (1913). 
Spokane  v.  Northern  Pacific  Ry.  Co.,  15  I.C.C.  376  (1909) ;  19 

I.C.C.  162  (1910);  21  I.C.C.  402  (1911). 
Tift  et  al.  v.  Southern  Ry.  Co.,  10  I.C.C.  548  (1905). 
Western  Advance  Cases  of  1915:  Freight,  35  I.C.C.  497;  Pas- 
senger, 37  I.C.C.  1. 

V.  State  Commissions 

Buell  v.  CM.  &  St.P.  Ry.  Co.,  1  W.R.C.R.  324  (1907). 
Cashton  Light  &  Power  Co.,  In  re,  3  W.R.C.R.  67  (1908). 
Gately  &  Hurley  v.  Delaware  &  Atlantic  T.  &  T.  Co.,  1  N.J.B.P. 
U.C.  519  (1912). 


214  BIBLIOGRAPHY 

Green  Bay  v.  Green  Bay  Water  Co.,  12  W.R.C.R.  236  (1913). 

Hill  v.  Antigo  Water  Co.,  3  W.R.C.R.  623  (1909). 

Mayhew  v.  Kings  County  Lighting  Co.,  2  P.S.C.  1st  D.,  N.Y. 

659  (1911). 

Milwaukee  v.  M.E.R.  &  L.  Co.,  10  W.R.C.R.  1  (1912). 
Oconto  City  Water  Supply  Co.,  In  re,  7  W.R.C.R.  497  (1911). 
Public  Service  Gas  Co.,  In  re  Rates,  1  N.J.B.P.U.C.  433  (1912). 
Queensborougb  G.  &  E.  Co.,  In  re,  2  P.S.C.  1st  D.  N.Y.  544  (1911). 
State  Journal  Publishing  Co.  v.  Madison  G.  &  E.  Co.,  4  W.R.C.R. 

501  (1910). 
Union  Electric  L.  &  P.  Co.,  Report  on,  St.  Louis  Public  Service 

Commission,  1911. 
United  Railways  of  St.  Louis,  Report  on,  St.  Louis  Public  Service 

Commission,  1912. 

DOCUMENTS,  REPORTS,  ETC. 
7.  United  States 

Commercial  Valuation  of  Railway  Operating  Property,  Bulletin 
21,  Bureau  of  the  Census,  1905. 

Evidence,  in  the  Matter  of  Proposed  Advances  in  Freight  Rates 
(1910  Advance  Cases),  Senate  Doc.,  725,  61st  Congress,  3d 
Session. 

Interstate  Commerce  Commission,  Annual  Report,  1888-1915. 

Statistics  of  Railways,  1888-1913. 

**  Interstate  Commerce  Commission,  Division  of  Valuation  (Va- 
rious Publications). 

National  Association  of  Railway  Commissioners,  Proceedings. 

Pacific  Railway  Commission,  Report  of  R.  P.  Morgan,  Engineer. 
Senate  Executive  Document  51,  50th  Congress,  1st  Session, 
page  4437. 

Railroad  Securities  Commission,  Report  to  the  President,  1911. 
""  Valuation  of  the  Several  Classes  of  Property  of  Common  Carriers, 
Report  of  the  Committee  on  Interstate  Commerce,  Senate  Re- 
port No.  1290,  62d  Congress,  3d  Session.    Senate  Report  on 
Valuation. 

II.  The  States 

Kansas,  Report,  Public  Utilities  Commission. 

Massachusetts,  Report  of  the  Joint  Commission  on  the  New  York, 

New  Haven  &  Hartford  Railroad,  The  New  Haven  Validation 

Report,  1910. 
Michigan,  Tax  Commissioners'  Report,  1900,  1902. 


BIBLIOGRAPHY  215 

Minnesota,  Report,  Railroad  &  Warehouse  Commission,  1908. 
Nebraska,  Annual  Report,  State  Railway  Commission,  1911-13. 
New  Jersey,  Report  on  the  "Revaluation  of  Railroads,"  1911. 
South  Dakota,   Annual  Report,   Railroad  Commission,   1910. 

"South  Dakota  Railroad  Appraisal." 
Washington,  Annual  Reports,  Railroad  Commission,  1905-08. 

///.  The  Presidents1  Conference  Committee 

Brief  filed  on  behalf  of  the  Railroad  Companies,  by  Pierce  But- 
ler, W.  G.  Brantley,  Herbert  S.  Hadley,  G.  S.  Patterson,  and 
Sanford  Robinson,  September  1,  1915.  The  Valuation  Brief 
of  1915. 

Circulars  issued  by  the  General  Secretary. 

Proceedings,  Valuation  Conferences. 


INDEX 


Adaptation:  roadbed,  110. 

Adjacent  land:  reproduction,  32- 
46,  86-90;  donated  land,  131-33; 
Federal  Valuation,  139. 

Alabama  Rate  Cases:  tax  values, 
21;  valuations,  30;  land,  38;  de- 
preciation, 83;  reproduction,  99; 
land  multiple,  132;  franchise, 
147-49;  rate  of  return,  192. 

Ames  v.  Union  Pacific:  valuation 
test,  9-18;  donations,  131;  con- 
demnation-regulation analogy, 
9-18,  156;  risk  in  railroad  opera- 
tions, 193. 

Analogy:  condemnation-regula- 
tion, 9-18;  donated  land,  131;  in- 
tangibles, 141;  land,  155. 

Arkansas  Rate  Cases:  tax  values, 
21;  intangibles,  187;  rate  of  re- 
turn, 192. 

Assessment:  value  of  land,  41-44, 
93;  Federal  Valuation,  86. 

Average  prices:  valuation  on  the 
basis  of,  65-67. 

Average  units:  ties,  water  stations, 
earth,  etc.,  70-71. 

Betterments:  solidification,  110; 
charged  to  operating  expense, 
114-16,  121;  Federal  Valuation, 
188;  surplus,  171-73. 

Bond  interest:  going  value,  177-78. 

Bonds:  see  Capitalization. 

Business  profits:  relation  to  depre- 
ciation reserve,  119-21;  risk  and 
foresight.  189,  202-05. 

California  Water  Cases:  valuation 
test,  15;  cost,  101-02,  126-27; 
bad  judgment,  107;  collapse  of 
the  boom,  127. 


Capitalization:  rule  in  Smyth  v. 
Ames,  16;  market  value,  19-21, 
147-49;  par  value,  22;  proceeds 
of  securities,  22-23;  franchise 
value,  Alabama  Rate  Cases,  147- 
49. 

Central  Yellow  Pine  Case:  improve- 
ments from  earnings,  114. 

Circle:  see  Vicious  circle. 

Cities:  relation  of  railroad  to  urban 
land  values,  88. 

Classification:  inventory  units,  57, 
95,  139. 

Comparative  plant:  going  value, 
160-62. 

Competition:  railroad  competition 
and  market  value,  Washington 
Commission,  152. 

Composite  property:  Valuation 
Brief  of  1915,  123. 

Condemnation:  analogy,  9-18; 
land,  35;  franchise,  141-46;  rail- 
way value  of  land,  155;  prelimi- 
nary deficits,  175. 

Confiscation:  Fourteenth  Amend- 
ment, 6;  rate  of  return,  Chapter 
VII. 

Connected  value :  going  value, 
159. 

Construction  period:  interest,  77; 
various  States,  77. 

Contingencies:  engineering  prac- 
tice, 47;  Justice  Hughes,  93. 

Cost:  see  Investment,  Unimpaired 
investment. 

Cost  of  Progress:  abandoned  prop- 
erty, 180-82. 

Cost  of  Reproduction:  see  Repro- 
duction. 

Credit:  relation  to  rate  of  return, 
194. 


218 


INDEX 


Damage:  land  multiple,  34. 

Deficits:  Wisconsin  theory,  166- 
77. 

Density  of  traffic:  market  value, 
Washington  Commission,  150; 
created  by  railroad,  203. 

Depreciation:  deduction,  28,  30; 
Supreme  Court,  Knoxville  Case, 
78;  obsolescence,  78,  116;  in- 
spection, 80;  life  tables,  81-84; 
replacement,  110;  operating  cost, 
117;  depreciation  reserve,  117- 
21;  unimpaired  investment,  136; 
Minnesota  Rate  Cases,  166;  cost 
of  progress,  180-82. 

Depreciation  reserve:  measure  of 
cost,  117-18;  "  uselessness,"  119; 
failure  to  establish,  119-21. 

Differential  advantages:  railroad 
site,  153-57. 

Discrimination:  Five  Per  Cent 
Case,  4. 

Donations:  right  of  way,  131-33. 

Earnings:  capitalization  of  earn- 
ings, 11;  Indiana  Tax  Commis- 
sion, 18;  Alabama  Rate  Cases, 
147;  Washington  Commission, 
150;  railway  value  of  land,  153- 
57. 

Economic  rent:  urban  site  rent  and 
the  adjacent  land  test,  92,  126; 
unearned  increment,  131;  rail- 
way value  of  land,  153-57;  crea- 
tion of  economic  rent,  202. 

Economist:  function,  28. 

Engineering:  percentage  measure- 
ment, 74,  93. 

Fair  average:  Justice  Hughes  on 
land  valuation,  91-93. 

Federal  Valuation:  Act  of  1913,  24- 
27;  land,  86;  cost  and  cost  of  re- 
production, 136-40. 

Five  Per  Cent  Case:  individual 
rates,  2-61 ;  flood  damage,  114. 

Fourteenth  Amendment:  confisca- 
tion doctrine,  6. 


Franchise:  Valuation  Act  of  1913. 

24;  valuation,  142-49. 
Future  prices:  "stiffening,"  63. 

Going  value:  Valuation  Act  of  1913, 
24;  good  will,  159;  comparative 
plant,  160;  reproduction  cost  as  a 
minimum,  164;  definition,  165; 
Wisconsin  doctrine,  166;  Santa 
Fe  figures  of  1910,  168-71;  sur- 
plus, 171-73;  New  Jersey  Gas 
Case,  177-87. 

Good  will:  defined,  159-60. 

Grants:  land,  inducement  for  in- 
vestment, 134. 

Hypothesis:  see  Reproduction. 
Hypothetical   outlay:     Minnesota 
Rate  Cases,  93. 

Improvements  from  earnings:  so- 
lidification, 110;  Central  Yellow 
Pine  Case,  114;  Federal  Valua- 
tion, 138;  surplus,  171-73. 

Inspection:  state  appraisals,  53; 
depreciation,  83. 

Intangibles:  Valuation  Act  of  1913, 
24;  considered  at  length,  Chapter 
VI. 

Interest:  during  construction,  76; 
legal  rate  as  a  fair  return,  191. 

Interstate  Commerce  Commission: 
reasonableness  of  rates,  1-6; 
Valuation  Act  of  1913,  24-27; 
Spokane  Case,  "by  no  means  a 
guess,"  54;  unit  prices,  67;  "waste 
and  extravagance,"  107;  im- 
provements from  earnings,  114- 
17;  original  cost  to  date,  136-40; 
cost  of  progress,  181 ;  return,  188- 
89;  unproductive  improvements, 
195-97. 

Intuition:  "railroad  intuition,"  95, 
133. 

Invested  value:  Knoxville  Case,  23. 

Investment:  proceeds  of  securities. 
22-23;  unimpaired  investment, 
28,  105-06,  135-39;  test  of  rea- 


INDEX 


219 


sonableness,  96-107;  land,  129; 
unearned  increment  in  earnings, 
204. 

Judicial  review:  confiscation  doc- 
trine, 6. 

Kansas:  valuation  of  the  Union 
Pacific,  31;  overhead  charges, 
75. 

Knoxville  v.  Knoxville  Water  Co.: 
rule  in  Smyth  v.  Ames,  17;  capi- 
talization, 22;  invested  value, 
23;  expert  appraisal,  60;  depre- 
ciation, 78;  unimpaired  invest- 
ment, 106;  going  value,  166. 

Land:  reproduction  hypothesis,  29, 
32;  multiple,  33-37;  "  true  value," 
35-37;  adjacent  land  test,  32-46, 
86-90,  124,  131-33,  139;  expert 
appraisal,  38-39;  sales  and  sales- 
assessment  method,  40-45;  Min- 
nesota Rate  Cases,  terminals,  41- 
45;  conjecture,  85-90;  Justice 
Hughes,  "fair  average,"  etc.,  91- 
93;  donations,  131-33;  unearned 
increment,  124-31;  Federal  Val- 
uation, 139. 

Lane,  F.  K.:  surplus,  116;  deficit 
theory,  167. 

Legal  expense:  percentage  allow- 
ance, 75. 

Life  tables :  depreciation,  80. 

Locomotives:  pound  prices,  72;  de- 
preciation, Washington,  82. 

Long  run:  cost  of  reproduction  as  a 
test  of  reasonableness,  103;  orig- 
inal cost  of  land,  129;  the  return 
to  the  railroad,  188-89;  unpro- 
ductive improvements,  198. 

Maintenance:  working  efficiency, 
109,  115,  120,  124;  creation  of 
capital  goods,  110-15;  simple  and 
composite  property  theory,  122- 
24. 

Market  value:  stocks  and  bonds, 


19-21;  Washington  Commission, 
149-53. 

Michigan:  valuation,  31;  multiples, 
34;  land  valuation,  experts  and 
locomotive  engineers,  38;  check  of 
1902,  40;  average  prices,  65;  en- 
gineering, 75;  inspection  for  de- 
preciation, 83;  cost  of  reproduc- 
tion as  value,  98;  intangibles,  186. 

Minnesota:  valuation,  31;  multi- 
ples, 34;  land  valuation,  terminal 
cities,  41-45;  inspection,  53; 
average  prices,  65;  overhead,  74- 
76;  specious  accuracy,  84;  cost  of 
reproduction  as  value,  98. 

Minnesota  Rate  Cases:  confiscation 
doctrine,  7;  rule  in  Smyth  v.  Ames, 
16;  stocks  and  bonds,  19-20;  pro- 
ceeds of  securities,  22-23;  repro- 
duction hypothesis,  32;  land  mul- 
tiples, 35-37;  state  land  valua- 
tions, 41-46;  contingencies,  47- 
50,  93;  appraisal  of  plant  (D.  C. 
Morgan),  52-59;  future  prices, 
63;  present  prices,  64;  average 
prices,  65;  tie  prices,  f68-70;  lo- 
comotives, 71;  freight  charges, 
73;  interest,  77;  depreciation,  78- 
80;  the  test  of  certainty,  85-90; 
"fair  average  of  normal  market 
value,"  etc.,  91-93;  Chas.  E. 
Otis,  reproduction  cost  as  pre- 
sent value,  99-100 ;  Justice 
Hughes,  present  value,  106,  124; 
maintenance,  109;  locomotive 
maintenance,  112;  unearned  in- 
crement, 126;  gifts,  131;  public 
streets,  132;  railway  value  of 
land,  153-59;  deduction  for  de- 
preciation, 166;  rate  of  return, 
risk,  etc.,  192-93. 

Missouri  Rate  Cases:  taxation 
value,  20;  rate  of  return,  192. 

Multiple:  basis  for  allowance,  33- 
36;  Alabama  Rate  Cases,  132. 

Nebraska:  valuation,  31;  inspec- 
tion, 53;  revaluation,  64;  over- 


220 


INDEX 


head,  75;  working  section,  78; 
cost  of  reproduction  as  value, 
98. 

New  Haven  Validation:  valuation, 
81;  contingencies,  47,  49;  inspec- 
tion, 56;  classification,  57,  61; 
average  prices,  65;  overhead,  75; 
interest,  76;  depreciation,  83; 
road  crossings,  100;  cost  of  pro- 
gress, 181. 

New  Jersey:  revaluation,  31;  Pub- 
lic Service  (New  Jersey)  Gas 
Case,  going  value,  177-87. 

New  York  Gas  Case:  real  estate 
valuations,  40;  depreciation,  80; 
pavement,  100;  unearned  incre- 
ment, 127-28,  130;  franchise, 
142,  145-46;  good  will,  159;  rate 
of  return,  192. 

Obsolescence:  importance  in  rail- 
road operations,  78-80;  C.  A. 
Prouty,  surplus  to  take  account 
of,  116. 

Overhead:  percentage  allowances, 
73,  95;  research,  74-76;  interest, 
76-78. 

Pavement:  cost  of  reproduction, 
100. 

Peabody,  James:  "shortage  of  re- 
turn," 168-70. 

Pioneer  risk:  land  grant  railroads, 
134;  railroad  in  a  new  country, 
190;  unearned  increment,  199- 
201. 

Pound  prices:  Minnesota  Valua- 
tion, locomotives,  71. 

Present  value:  rule  in  Smyth  c. 
Ames,  7-10,  106,  124,  138;  cost 
of  reproduction  as  value,  28,  98- 
100;  land,  Minnesota  Rate  Cases, 
124,  128. 

Prices:  unit  prices  and  judgment, 
61-63;  future  prices,  63;  present 
prices,  64;  average  prices,  65; 
Valuation  Brief  of  1915,  67-68; 
commodity  off  the  market,  68; 


average  units,  70-72;  general 
level  of  prices  and  wages,  101, 
194-95. 

Profile:  estimates  inaccurate,  55. 

Profits:  relation  to  depreciation  re- 
serve, 119-21;  risk  and  foresight, 
189,  202-05. 

Progress:  abandonments  as  the 
cost  of  progress,  180-82. 

Prouty,  C.  A.:  Eastern  Advance 
Case  of  1910,  4,  6,  26,  115,  189, 
198;  rule  in  Smyth  t>.  Ames,  16, 
138;  capitalization,  market  value, 
20-21;  need  for  valuation,  26; 
Spokane  Case,  54,  171;  Federal 
Valuation,  land,  86;  prices,  105; 
unproductive  improvements,  115, 
195-96;  obsolescence,  116;  cost 
to  date,  136-38;  typical  rail- 
roads, 189. 

Railroad  Securities  Commission: 
par  value  of  securities,  22;  cost 
of  reproduction,  "most  impor- 
tant single  element,"  97;  unpro- 
ductive improvements,  199-200. 

Railway  value:  land,  Minnesota 
Rate  Cases,  153-59. 

Reagan  v.  Farmers'  Loan  &  Trust 
Co.:  condemnation -regulation 
analogy,  9;  cost  and  value,  128. 

Rent,  economic:  dependent  on  the 
presence  of  the  railroad,  92;  rail- 
road site,  131,  153-59;  railway 
value  of  land,  153-59;  creation  of 
economic  rent,  200-01. 

Representative  railroad:  Wiscon- 
sin deficit  theory,  174-76;  rela- 
tion to  the  rate  of  return,  189, 
195. 

Reproduction:  rule  in  Smyth  v. 
Ames,  16-18;  Valuation  Act  of 
1913,  24;  definition,  29,  50;  state 
appraisals,  30-31,  51-57;  land, 
32-37;  true  value,  37-46;  con- 
tingencies, 47-50;  imagination, 
50;  prices,  63-72;  overhead,  73- 
78;  depreciation,  78-84;  the  test 


INDEX 


221 


of  certainty,  85-96;  cost  of  re- 
production and  reasonableness, 
96-107;  present  value,  97-102; 
Federal  Valuation,  139. 

Research:  overhead  percentages, 
74-75. 

Reserve:  depreciation,  117-21; 
measure  of  cost,  117;  "useless- 
ness,"  119;  failure  to  establish, 
119-20. 

Resurvey:  inadequacy,  55;  Fed- 
eral Valuation,  139. 

Return:  confiscatory,  6;  consid- 
ered at  length,  Chapter  VII. 

Revaluation:  New  Jersey,  31;  peri- 
odic revaluations,  105. 

Risk:  railroad  operations,  107,  134, 
190,  199. 

Rule:  Smyth  v.  Ames,  considered 
in  detail,  15-23;  Valuation  Act  of 
1913,  27;  market  value,  Wash- 
ington Commission,  149. 

St.  Louis  Public  Service  Commis- 
sion: land,  125;  actual  cost,  135. 

Sales-assessment:  Wisconsin,  40- 
44;  Minnesota  Rate  Cases,  43- 
45;  Federal  Valuation,  86. 

Sales  method:  definition,  W.  D. 
Pence,  40. 

Simple  property:  Valuation  Brief 
of  1915,  122-24. 

Smyth  v.  Ames:  valuation  doctrine, 
7,  10;  "average"  reduction  in 
rates  and  earnings,  12-14;  the 
rule,  15-23;  market  value,  Wash- 
ington Commission,  149. 

Solidification:  roadbed,  110. 

South  Dakota:  valuation,  31;  con- 
tingencies, 49;  inspection,  53; 
average  prices,  65;  land  valua- 
tion, 70-71;  engineering,  78;  de- 
preciation, 83. 

Spokane  Case:  valuation  of  North- 
ern Pacific  and  Great  Northern, 
54;  average  structures,  58,  71; 
future  prices,  63;  surplus,  116, 
171. 


State  Appraisals:  Kansas,  31,  75; 
Michigan,  31,  38,  40,  49,  52,  65, 
75,  83,  98,  111,  186;  Minnesota, 
31,  34,  36,  42,  53,  65,  74,  75,  84, 
98,  140;  Nebraska,  31,  53, 75,  78, 
98;  New  Jersey,  31;  Oregon,  31; 
South  Dakota,  31,  49,  53,  65,  70, 
75,  78,  83,  102,  140;  Texas,  31; 
Washington,  31,  35,  39,  49,  52, 
55,  64,  82,  84,  98,  101,  140, 
149,  153;  Wisconsin,  31,  34,  35, 
40,  49,  52,  65,  71,  75,  83,  98, 
111. 

Stocks:  see  Capitalization. 

Strategic  value:  market  value,  149; 
advantageous  site,  158-59. 

Streets:  reproduction,  Minnesota 
Rate  Cases,  132. 

Superintendence:  percentage  al- 
lowance, 73;  Minnesota  Rate 
Cases,  93. 

Surplus:  reality,  115-17;  deduc- 
tion, 171-73. 

Taxation:  Missouri,  Arkansas,  and 

Alabama    Rate    Cases,    20-21; 

franchise,  142-47. 
Terminals:  adjacent  land,  88-90; 

strategic  importance,  198. 
Texas:  valuation,  31. 
Ties:  unit  prices,  Minnesota  Rate 

Cases,  68-70. 
Traffic     density:     market     value, 

Washington    Commission,    150; 

railroad  management,  203. 

Unearned  increment:  land  value, 
124-31;  "give  and  take"  argu- 
ment, 126;  Supreme  Court,  New 
York  Gas  Case,  127;  alienation 
argument,  129;  income,  130,  204- 
05. 

Unimpaired  investment:  definition, 
28, 105-06;  Knoxville  v.  Knoxville 
Water  Co.,  106;  appraisal,  135- 
39. 

Unit  miles:  valuation  of  Northern 
Pacific,  J.  B.  Berry,  70. 


222 


INDEX 


Unproductive  improvements:  paid 
for  out  of  earnings,  195-98. 

Valuation:  the  genesis  of  the  doc- 
trine, 7-8;  the  condemnation- 
regulation  analogy,  9-11;  Valua- 
tion Act  of  1913,  24-27;  Federal 
Valuation,  cost  to  date,  136-40. 

Vested  interests:  widows  and  or- 
phans, 22;  deduction  for  depre- 
ciation accrued,  121-22. 

Vicious  circle:  condemnation-regu- 
lation analogy,  11;  Justice 
Holmes,  14;  capitalization,  19, 
148;  taxation,  20,  144-49;  land, 
133,  156-57;  franchise,  144-46; 
Washington  Commission,  J152 ; 
railway  value, '156-57;  compara- 
tive plant,  162. 


Washington:  valuation,  31;  land, 
35,  39;  contingencies,  49;  check- 
ing of  records,  52;  resurvey,  55; 
revaluation,  64;  depreciation, 
81-84;  cost  of  reproduction  as 
value,  98;  exploration  surveys, 
101;  market  value,  149-53. 

Willcox  v.  Consolidated  Gas  Co.: 
see  New  York  Gas  Case. 

Wisconsin:  valuation,  31;  mul- 
tiple, 34;  land,  35,  40;  contin- 
gencies, 49;  thoroughness,  D.  C. 
Morgan,  "numbers  in  a  hat," 
52;  average  prices,  65;  earth, 
71;  overhead,  75;  depreciation, 
83;  cost  of  reproduction  as 
value,  98;  adaptation,  111. 

Working  efficiency :  maintenance, 
109,115,  120,  124. 


IF  .  S  .  A 


OVERDUE. 


REC'D  LD 

FEB261957 


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